Capitol Gains Question for Reinvesting

[Jessica Ramsey]

My husband and I are very familiar with investment properties- we own several rentals, but are looking to start flipping this year and hopefully make a career out of it. I’m trying to become more knowledgeable on Capitol Gains but don’t see a lot of specific detail so my question is:

If we purchase a home and take out a mortgage on it (putting down the required 15% or more + using cash for renovations) then renovate and flip, are we able to pay the mortgage off and reinvest the profit without getting hit with capitol gains?

Notes:

-the mortgage pay off would be less than property appraisal (not cut into profits made)

-the profits made would roll into a new investment property within 180 window

[Dave Foster]

@Jessica Ramsey, The mortgage is irrelevant to your potential tax hit.  And capital gains tax rate is not available on a property you have owned for less than one year.  

When you buy the property that purchase price is your starting basis.  To that you add your capital improvements and subtract depreciation (not applicable in a flip of course).  This is your adjusted cost basis.  The difference between your adjusted cost basis and the net sales price when you sell is the profit you will pay tax on.

Tax when your primary intent is to flip is at your ordinary income rate which could include federal, state, self employment, and ACA surcharge (as much as 40% depending on where you live and pay tax).  

The 1031 exchange can defer that tax indefinitely and allow you to sell and then purchase new property without paying the tax.  But the 1031 is only available when your intent in purchasing a property has been to hold for productive use (like you do with your long term rentals).

There is no specific holding period.  But there is the issue of demonstrating your intent.  

If you think you can grab the scale to move into full time flipping it can be a very fun and rewarding career.  But it's very costly from a time and expense perspective - especially taxes.  You've got to have plenty of deals in the pipe line to offset those taxes and cover reno costs.

Some folks in your situation choose to continue their path of buy and hold investing.  But they add a component of refinance to get cash out of their rehabs to reinvest in new property.  And then they evaluate their portfolio constantly for properties that would be a candidate to sell and 1031 (tax free).

It's not a fix in flip scenario where you get hammered on taxes. It's not a BRRR model where you simply hold for cash flow. What you're doing is buy rehab rent refi reinvest the refi in new properties and then re-evaluate your portfolio for appropriate properties for sale. Kind of the best of both worlds.