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Near the top of the list of pitfalls for anyone who wants to make
money flipping houses is failure to understand and plan for the tax
consequences, says Michael Cain, a certified public accountant
based in Woodland Hills, Calif.

The current law allows a seller to keep, tax-free, gains of up to
$250,000 (or $500,000 for married couples filing jointly) on the sale
of a primary residence if the seller has lived in it for 24 of the
previous 60 months.

For investment homes — and those in which the owner did not live
for at least two of the previous five years — the Internal Revenue
Service assigns taxes according to the length of time it was owned
before a sale. Profits from homes owned for one year or more are
taxed as capital gains, at the current rate of 15 percent, plus state
taxes. Profits from homes owned for less than one year are taxed
the same as regular income, according to the bracket in which the
seller falls, anywhere from 25 percent to 35 percent.

The savvier approach, Cain says is to move the proceeds of a home
sale into another investment property of roughly equal value, a
procedure known as a like-kind or 1031 exchange. IRS rules give
investors 45 days from the time they sell a property to identify the
exchange property and 180 days to make the exchange. Investors
can't receive any cash from the sale, so all money must be held by
qualified intermediaries, such as a title company.

What home flippers hope to avoid is being labeled a "trader
business" by the IRS. Those are investors whom the IRS identifies
as making their living off the buying and selling of homes. In that
case, flippers will not only have to pay the higher income tax rates,
but they also will have to pay 15.3 percent in self-employment taxes.

Source: The Los Angeles Times, Todd Stein (04/23/06)