Understanding the self-employment tax
When it comes to earning income, the Internal Revenue Service (IRS) expects individuals to pay taxes on their earnings, regardless of how they earn the money. For those who work for an employer, income taxes are typically withheld from their paychecks automatically. However, for individuals who are classified as self-employed, the rules are different. Self-employed individuals are expected to pay both their portion of taxes (Social Security and Medicare) as well as their employer’s portion. This is commonly referred to as the self-employment (SE) tax, which currently stands at 15.3% of the individual’s net earnings from self-employment.Interesting Read What type of loan is best for a manufactured home? Your guide to financing options.
What is flipping houses?
Flipping houses refers to the practice of buying a property, renovating or rehabilitating it, and then selling it for a profit. This process can be very lucrative if done correctly. In recent years, many people have turned to flipping houses as a way to earn an income. However, flipping houses can come with some tax implications that individuals need to be aware of before getting started.Criteria for a property to be considered a flip
When it comes to flipping houses, the IRS has specific criteria that a property must meet to be considered a flip. In general, a property must be bought with the intent to resell it quickly. Additionally, the property must undergo significant improvements before being sold. If these criteria are met, then the property can be considered a flip. Some examples of significant improvements include:- Adding new flooring
- Replacing the roof
- Updating the kitchen and bathrooms
- Painting the interior and exterior of the property
IRS rules for classifying a flip investment
The IRS has specific rules for classifying a flip investment. To be considered a flip, the property must be held for less than one year. Additionally, the property must have been sold for a profit. If the property is held for more than one year, then it is classified as a long-term capital gain. Long-term capital gains are taxed at a lower rate than short-term gains, which can make a significant difference in the amount of tax owed.Determining if flipping houses is considered self-employment
Whether or not flipping houses is considered self-employment depends on the individual’s specific situation. If a person flips houses as a hobby, then the income may be classified as ordinary income. However, if a person is regularly flipping houses and earning a profit, then the IRS may classify the individual as self-employed. Some factors that the IRS may consider when determining whether or not someone is self-employed when flipping houses include:- The frequency of flips
- The amount of time and effort put into each flip
- Whether or not the individual has a separate business entity for flipping houses
How the SE tax affects profits from flipping houses
If a person is classified as self-employed when flipping houses, then they will be subject to the SE tax. This tax can significantly reduce the amount of profit earned from flipping houses. For example, if an individual earns a profit of $100,000 from flipping houses, then they would be required to pay $15,300 in SE tax.Tips for avoiding SE tax liabilities while flipping houses
There are several tips that individuals can follow to avoid SE tax liabilities while flipping houses. One way to reduce the amount of SE tax owed is to establish a separate business entity. This can help reduce the individual’s tax liability and provide additional legal protection. Additionally, individuals can try to limit the number of flips they do each year. By doing so, the IRS may be less likely to classify them as self-employed. Other tips for avoiding SE tax liabilities when flipping houses may include:- Keeping detailed records of all expenses related to each flip
- Consulting with a tax professional to determine the best business structure for flipping houses
- Looking for opportunities to offset SE tax liabilities with business expenses and deductions