There are various tax implications to take into account when investing in real estate.  The first is for “flipping” real estate, which is buying a property, doing a quick fix up and reselling it, hopefully at a profit.  If you hold the property less than a year it’s a “short term capital” gain meaning any profit is taxed at your ordinary income tax bracket, which could be as high as 35%   If you hold the property for more than a year before selling at a profit you receive a long term capital gain as defined by the tax code and that tax rate is a maximum 15% in most cases.  The 15% rate was set to expire in 2008, but has been extended through 2010 as a result of the Tax Increase Prevention and Reconciliation Act signed into law in 2006.  In 2011 the rate “sunsets” or reverts back to its previous rate if there is no further action by Congress. 

Another situation to be aware of for flippers is the frequency with which properties are bought and sold.  If you are moving a large volume of properties in short order and deriving most of your income from this endeavor, the IRS may not view this as a capital gain, but a business, which will be taxed accordingly.  On top of that you may be liable for 15.3% in additional self employment taxes. 

There are few ways to avoid paying the higher rate to the IRS. The first is holding the property over a year for the lower capital gains rate.  Another possibility is making the property your primary residence.  If you live there for 2 yrs, there is an exemption on taxation up to $250,000, double that if married and file jointly. 

There’s also the option of doing what is called a 1031 Exchange.  It’s the option to avoid taxes on the swapping of similar properties as long as the property to be exchanged is identified within 45 days and closes within 180 days.  There also is the stipulation that both assets must be income producing.

The tax code is constantly changing and there are a lot of variables to consider, that’s why it is best to consult a tax professional.  It is also important to keep good and detailed records to maximize your deductions and prevent the IRS from contesting them. 

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