June 6, 2022

I think we all know at this point that real estate is one of the best ways to attain financial freedom. Everyone spends on real estate. People are always paying rent or buying homes, moving from one town to the other, doing home improvements, or selling their homes to buy a new home in a better area. You can always count on real estate bringing you some returns because people will always pay.

Here's the thing – there’s big differences between the different types of real estate investing. You can fix and flip, buy and hold, buy REITS, and so much more. And each one of these options has very different tax implications. Let’s dive into the difference between fixing and flipping real estate, and buying and holding real estate, all from a real estate CPA perspective.

Fix and Flip

As the name suggests, you buy a property, fix it, and sell it for a profit. What happens here is that you find a cheap or rundown place and buy it at a very low price. After you have purchased it, you then repair and renovate the house and sell it for a far greater price than you invested in it.

Fixing and flipping may not be as straightforward as it sounds. But there’s a 70% rule that helps. The 70% rule states that when scouting for property to fix and flip, estimate how much you could sell it for after all necessary fixing and renovation (after repair value ARV). Then calculate 70% of this and subtract how much you need for the repairs. Do not pay any more than this final value for a home you intend to fix and flip.

Buy and Hold

If you're familiar with crypto, you may have an idea of this term. In real estate, this is a long-term investment strategy where investors buy a house, hoping that it will appreciate in value over time. While they are waiting for it to appreciate in value, they rent it out. Sometimes, if the house was bought with a mortgage, the returns from the rent are used to clear the bill.

Fix and Flip vs. Buy and Hold: Taxes

In essence, the biggest difference between these two options from a tax perspective is whether you have the asset when all is said and done. Fix and flippers are taxed upon sale of the property, and they no longer have the property (or the tax benefits that are associated with it). Buy and hold investors are only taxed on the rental income from the property, and since they’re keeping the property, they get all the benefits associated with it – depreciation, the ability to refinance and withdraw equity, and the cashflow.

Reporting taxes on short-term rental on schedule C or Schedule E

Both Schedule C and Schedule E forms report income, profit, and loss.

Schedule C reports profit or loss from business, while Schedule E reports supplemental income and loss. When short-term rentals and reporting taxes are concerned, you need to consider what kind of short-term rental you run.

Your short-term rental may be a business that confers a self-employed status on you. In this case, it’s likely that you actively participate in the business and provide substantial services such as housekeeping, laundry, or maintenance. In this case, you should report your short-term rental on a Schedule C “profit and loss from business” form.

However, if you have another business and you only run a short-term rental passively without necessarily participating or offering substantial service, then you can report it on the Schedule E “supplemental income and loss” form.

If you run an Airbnb without providing those substantial services, you should file a Schedule E, however if you are providing substantial services such as cooking, cleaning, while the guest is STAYING, then you would file Schedule C for your STR.

Owning property together and taxes

It’s common for a married couple to own property together; they can report rental income as well as a tax deduction with the Schedule E form. They can file tax returns together or separately. If together, income and expenses won’t be divided between the two. However, income and expenses will be divided if they file separately.

Buying real estate can be very capital-intensive, so you can choose to pool resources together with a friend or partner to whom you aren't married and buy a property. This is also a fairly common practice. As far as taxes are concerned, each partner should file income and expenses separately using the Schedule E form. This should correlate with the percentage of ownership each partner has. If they have an equal stake in the joint partnership, then, of course, they file equal income and expenses. 

Generally, the partnership should have:

●     An IRS EIN

●     An account where you can record expenses and income.

●     An Operating Agreement.

House Hacking and Taxes

When you own a home and have an extra space that you aren't using, house hacking is the perfect way to make that space productive. House hacking is a fairly common money-making strategy. People rent out space in their residences to generate money. The extra space they rent out can be rooms in the house or extra quarters outside the house. One house hacking method is to rent out the free room in your home on Airbnb. The money gotten from this venture can then be used to pay off the mortgage or any other house expense. House hacking provides extra cash flow in the form of passive income and has tax benefits.

The tax benefits of house hacking

House hacking makes you a landlord, which means you can get some particular tax benefits like tax deductions for property tax, interest payments, and some home-related expenses such as utilities and maintenance.

However, reporting your expenses in the house can get confusing, especially if you share some space with your renters. You may not be able to report some expenses as house maintenance. In this case, you may need a certified public accountant.

However, if you're living in different parts of the building and your living space doesn't intersect, you can report all the interactions with ease and easily calculate what you report for principal tax exceptions.

Real estate taxing has a lot of nuances to it, and it may seem complicated at first, but it’s easier to deal with and understand once you understand your particular position.