The tax rules surrounding flipping properties, unlike rent-to-owns, as described in a previous article, are slightly more straightforward. But, using the proper structure is still critical. Think of this as a short primer on those rules, and how they may affect your taxes as you plan your real estate investment business with your real estate accountant and team of other professionals.
Accounting for flips held in a corporation
Generally speaking, if you are in the business of acquiring properties, renovating them and selling them for a profit, you are earning “active” business income. Whether profit from a flipped property is treated as business income or a capital gain ultimately always comes down to intention – what was your original plan, what you documented, what actually happened? But that’s a whole other article! For this explanation we are going to talk about the active side. If you will be taxed as if you received income, you will be taxed on 100% of your profits vs. 50% of your profits for capital gains.
Similar to the point mentioned for RTOs, any property you hold while it is being renovated, or is currently for sale is considered an inventory item, and not a depreciable capital asset.
The cost base of your property increases as you renovate it. Major renovations, small repairs, cosmetic updates, utilities paid at the property while being worked on, all get capitalized. These items are capitalized because you are getting your “inventory” ready for sale.
At the time of sale your business income will be your proceeds of sale, less your updated cost base of the property. This active income is taxed as business income. Assuming that you qualify for the lower rate of tax in Ontario, this will be 15.5%, or 14% in Alberta, for example. A limited amount of “soft” costs may be deducted for tax purposes each year as well, such as some property taxes, utilities, etc..
I don’t have a corporation…my flip is personally held
Alright, sounds simple enough – flips are considered taxable income (not capital gains). Again, more tax planning needs to happen here as your business income combined with other sources of income earned personally will increase your total tax payable – especially if you climb up into a higher tax bracket.
George E. Dube, CPA, CA
Real estate accountant, real estate investor, speaker, author