Vol 6 No. 31 - April 26, 2006

Watch for pitfalls when flipping homes

By Louise Bolger
SUN STAFF WRITER

If you have a passion for homes, love to renovate and have an eye for a bargain, you have some of the best qualifications for being a "flipper." No, this has nothing to do with dolphins but does have everything to do with investing in real estate.

The entire country has been caught up in the feeding frenzy of real estate investment during the past five to seven years of phenomenal growth. It seems that everyone from first time homeowners to your grandmother thinks they can invest in real estate and come out a winner. Some of that thinking has been true. Low interest rates and extraordinary appreciation rates have made real estate appear to be a better investment than putting money in your 401K, but there are pitfalls.

Overextending on purchase price and overspending on repairs can send your investment budget into the ozone. Couple that with a volatile market, which has decided to take a downturn, even just a small one, can put you in the position of not being able to meet your monthly mortgage notes and not being able to sell the property. The bottom line is you need to know what you're doing. Start small with a property that's in relatively good condition, one that you know you'll be able to rent if need be and have enough backup money to carry you through a potential bad spell.

OK, now you know what you're doing as far as purchasing. How about taxes?

The IRS tax structure for investment property is as complicated as it comes. Believe it or not, there are investors who aren't aware that in 1997, the IRS ended the rollover provision, permitting profits from a home sale to be applied to another purchase without the seller having to pay taxes on the gain. The current law allows a seller to keep tax free gains of up to $250,000 ($500,000 for married couples filing jointly) on the sale of a primary residence if the seller has lived in it for 24 of the previous 60 months.

If you sell an investment house, however, taxes are assigned according to the length of time it was owned before a sale. Profits from homes owned for two years or more are taxed as capital gains at the current rate of 15 percent. Profits from homes owned for less than two years are taxed the same as regular income based on the seller's tax bracket, which could be anywhere from 25 to 35 percent.

The only way to avoid or reduce tax on real estate investments is to live in the home for two years, fix it up and then sell it, taking advantage of the $250,000 or $500,000 exemption provision. Or hold on to the property long enough to qualify for the capital gains rate. Or purchase another investment property of roughly equal value and take advantage of a 1031 Exchange, where all of the tax on profits is deferred. The thing not to do is to have the IRS label you as a "trader business," defined as those who make their living off the buying and selling of homes. Traders are subject to higher income tax rates and self employment tax.

Anything to do with IRS regulations needs professional advice, especially when it comes to investing in residential property, consult your accountant or CPA before signing a contract of sale.

If investing in real estate is a contact sport where you stand the risk of getting tackled, then flipping real estate belongs in the Roman Coliseum with the gladiators.

Sometimes it just might be better to sit on the dock and watch "Flipper" rather than get in the water with him.

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