Flippers still profit in real estate slowdown

But selling too soon after renovation has tax, profit consequences
By: Robert J. Bruss: Inman News
Are you a real estate "flipper" or a "keeper"? Most home buyers are keepers, owning their houses and condos for five or more years. However, even as residential sales prices currently "stagnate" or "plateau" in most cities, according to the latest statistics from the National Association of Realtors and other sources, flippers continue to profit.

WHAT IS A REAL ESTATE FLIPPER? There is no official definition, but a real estate flipper is a buyer who acquires a property and holds title less than 12 months. Other names for property flippers are "quick turn specialists" and "speculators."

"Buy low, sell high" is the motto of flippers.

There's nothing wrong, illegal, immoral or fattening about that. However, buying low and selling high isn't always easy.

Real estate flippers usually must add value to earn profits. Not only do flippers buy 25 percent or more below the market value of equivalent property in good condition, but they increase the purchased property's desirability by improving it to increase the value more than the costs incurred.

The most profitable real estate example of adding more value than the improvement costs is fresh paint. Everybody has witnessed a shabby run-down house suddenly brought to life by exterior painting.

Although your results will vary, spending $1,000 on exterior paint of a house often produces $10,000 increased market value, sometimes more. Interior paint can produce similar profitable results.

SPECIAL TAX BREAK FOR OWNER-OCCUPANT FLIPPERS. If you enjoy tax-free income, consider becoming an owner-occupant flipper. That means you buy a house or condo, move in to make it your full-time principal residence for at least 24 months, and then profitably resell it after making valuable improvements that add more market value than they cost.

Thanks to Internal Revenue Code 121, your principal-residence sale profit is then tax-free up to $250,000 (up to $500,000 when both spouses meet the occupancy test and file a joint tax return in the year of sale).

WHO SHOULD BECOME A REAL ESTATE FLIPPER? Flipper properties are especially attractive to beginner real estate investors getting started. Having earned substantial profits from fast-flip properties, I am aware the profits don't always materialize as quickly as expected.

For this reason, especially for the first few properties, a "get rich slow" attitude is best. Later, after experience is gained, flipping properties becomes easier, perhaps even developing into a full-time profitable business.

Flippers are especially ideal for investors with a flare for spotting sound, well-located real estate in need of upgrading. When you see a run-down house and cry out "yuck," you are a potential property flipper.

SECRETS OF PROFITABLE PROPERTY FLIPPERS. Although any type of property can be flipped, most flippers specialize in houses because they offer the best potential and the largest market of prospective buyers. The secrets of profitable property flips include:

1. Find a motivated seller who wants to sell due to an urgent reason and is willing to sell below market value in return for a quick sale. Strong seller motivations include out-of-town job transfers, unemployment, divorce, financial problems, illness, death in the family, and moving to a better house.

2. Look for fix-up properties needing inexpensive cosmetic work. "El dumpo" houses often just need fresh paint, new light fixtures, cleaning and minor repairs, new carpets and flooring, and fresh landscaping.

Examples of unprofitable but necessary fix-up work to avoid include structural changes, new roof and foundation repairs, which are very expensive but add little or no market value.

3. Search sources of "fast flip" properties, including real estate agents, newspaper classified ads, foreclosure sales, probate sales, bankruptcies, expired MLS (multiple listing service) listings, vacant rental houses, absentee out-of-town owner lists, and properties with unpaid property taxes.

4. Drive around desirable neighborhoods looking for vacant, run-down or abandoned houses. Jot down the address, take a digital photo to remember the house, and then check the owner's mailing address at the tax collector's office to discover an owner who might be anxious to sell.

If you discover a house that has been owned for many years, often with a small or no mortgage and a large equity, that owner might be extremely eager to sell at a bargain price.

DISADVANTAGES OF FLIPPERS. But flipper properties, even when they produce large profits, are not without possible disadvantages such as:

1. Profits from the sale of investment properties held less than 12 months are taxed at ordinary income tax rates. However, when a flipper holds title more than 12 months, then the sales profits are taxed at the long-term capital gains tax rate, currently 15 percent or less, plus applicable state tax.

Of course, if you own and occupy the property as your principal residence more than 24 months within the last 60 months before selling, then your profit up to $250,000 (up to $500,000 for a qualified married couple) is completely tax-free. Home sellers who repeatedly sell their homes every 24 months are known as "serial home sellers."

2. Some flippers don't enjoy the work of fixing up property to add market value. Serious flippers quickly learn do-it-yourself work wastes time and money. The smartest flippers hire professional contractors. However, obtaining cost estimates and supervising workers can be time consuming.

The goal of every property flipper is to add at least $2 of market value for each $1 spent on cosmetic improvements. Wise management can often orchestrate improvements on a typical house to completion within 30 and 60 days.

3. Fast flippers who sell quickly after completing their added-value improvements forfeit long-term market-value appreciation, which has averaged about 5 percent annually, according to the National Association of Realtors. In recent years, this annual appreciation was even greater.

CONCLUSION: Flipping properties for resale profits is a great way to start investing in real estate. But flippers should be aware of the pros and cons of this profit opportunity, including the income tax aspects of long- and short-term profits. A valuable resource is an excellent new book, "Flipping Properties for Dummies," by Ralph Roberts, available in stock or by special order at local bookstores, public libraries, and www.Amazon.com.