Flipping houses

[cathe]

I have several clients who are coming in this year with a house flip. These are not business returns, often simple 1040's. Where do I put the flips? Sch D? Doesn't seem like enough info is entered there, but I don't know where else to put them. Where do you put them?

Cathe

[JoshinNC]

It depends

Are they planning on doing more flips? How many flips did they do last year? How did they market their flips? Did they use a realtor to sell the houses or sell them as "for sale by owner"?

The answers to these questions will indicate whether you have a Sch. C business or a Sch. D investment.

[jainen]

Line 21

>>Sch. C business or a Sch. D investment<<

You might have Line 21 miscellaneous income instead, if the earnings are primarily from their activity (such as fixing up the place) but it does not constitute a business.

[JoshinNC]

It could be a business

If I hold myself out as a company that buys dilapidated homes, refurbishes them and sells them, I am operating a business. Even if I don't form a formal entity or even get a DBA, the IRS could well say that I am running a business if I continually engage in this activity for profit. This would be a Sch. C activity, in my opinion. However, if I bought 1 house per year, hired contractors to remodel it and then hired a realtor to sell it (i.e. I had no personal involvement) than it's an investment.

[cathe]

Not a business

I don't think any of these people are going to try this again soon. Housing market decline hit all of them at the wrong time. Sch D or line 21? Capital gain or straight income?

[Bird Legs]

Flippin Houses

How long did they own the houses before selling?

[jainen]

The key question

>>I had no personal involvement<<

That would only determine whether the owner had a passive activity, not whether it was an investment.

The key question is whether the change in price is due to external market pressures (such as interest rates, supply & demand, other building in the neighborhood, etc.) which is characteristic of an investment. If not, the new value comes from the work that is done in remodeling, which is characteristic of a business if done in an ongoing and regular way with appropriate bookkeeping and so on, or a non-business activity reported on line 21.

[LawrenceGR]

More than one party

If there is more than person involved would this not be a partnership? If their intent was to buy the and resell for a profit I think I would call it a business. Intent I think is the important word here.

[cathe]

Only the few months that it took to remodel.

cathe

[cathe]

These people are all independent of each other. There has just been a lot of people trying house flipping in this area. TV makes it look so easy, you know.

cathe

[JoshinNC]

If they only did one house, and you only had one investor,

than you have a Sch. D capital gain (loss). If they did multiple deals or you had multiple investors, you may have a business.

[OldJack]

The key question is whether the change in price is due to external market pressures (such as interest rates, supply & demand, other building in the neighborhood, etc.) which is characteristic of an investment. If not, the new value comes from the work that is done in remodeling, which is characteristic of a business if done in an ongoing and regular way with appropriate bookkeeping and so on, or a non-business activity reported on line 21.

I think you would have to agree that the subject house is a code section 1221 asset unless it is a business asset (see quote definition). The last I knew code section 1221 assets were reported on 1040 Sch-D, not line 21. A hobby would be reported on line 21, but not the sale of the capital asset used in the hobby. I don't think there is anything in the code that says the value of §1221 asset cannot be increased by improvements. Call it whatever you want but if it falls under the definition as quoted without being excluded under ¶ 1-3 below (or some other code), its a capital asset for Sch-D.

Sec. 1221. Capital asset defined

-STATUTE-
(a) In general
For purposes of this subtitle, the term "capital asset" means
property held by the taxpayer (whether or not connected with his
trade or business), but does not include -
(1) stock in trade of the taxpayer or other property of a kind
which would properly be included in the inventory of the taxpayer
if on hand at the close of the taxable year, or property held by
the taxpayer primarily for sale to customers in the ordinary
course of his trade or business;
(2) property, used in his trade or business, of a character
which is subject to the allowance for depreciation provided in
section 167, or real property used in his trade or business;
(3) a copyright, a literary, musical, or artistic composition,
a letter or memorandum, or similar property, held by - ...........
.................................................. ....................

[jainen]

I would indeed agree

>>A hobby would be reported on line 21, but not the sale of the capital asset used in the hobby<<

I would indeed agree that the house is a capital asset if it is not business property. Everything in the world is. But that doesn't mean the gain realized on sale is not ordinary income.

It depends on what the gain is from. Is it from the property itself, or from an activity using the property? Consider something that is obviously a hobby, such as a woodworker who makes windmills for his neighbors' mailboxes. There is no real profit motive and he doesn't do it regularly enough to constitute a business, although he does get paid enough to cover his materials and a little something for his time. By the definition you quoted the windmills are capital assets. Do you report the sales on Schedule D? Of course not--the profit comes from his time and effort, not the bull market for postal toys.

In the same way, fixing up real estate is an activity -- business or not -- which creates the gain that is not inherent in the property as is.

[geekgirldany]

I had the same thing happen last year. Except these customers were buying four houses and flipping them in a year. Several people involved in the flip. I told them to setup a partnership LLC, keep a separate bank account, and that this was a business.

Here is a article I found that is pretty good:

http://www.bankrate.com/brm/itax/news/taxguide/flippers1.asp?caret=13

[OldJack]

By the definition you quoted the windmills are capital assets. Do you report the sales on Schedule D? Of course not--the profit comes from his time and effort, not the bull market for postal toys.

In the same way, fixing up real estate is an activity -- business or not -- which creates the gain that is not inherent in the property as is.

I completely disagree that improvements to real estate "is not inherent in the property as is". Improvements are in fact additions to the cost basis of real estate [Sec. 263. Capital expenditures] and are treated as part of the cost basis in determining gain regardless of what tax form the asset sale is reported on, if it is a business asset or personal asset.

A real estate fix-up activity, as such, does not mean it is a business activity or that the gain from such asset used in the activity somehow is automatically treated as ordinary income. It is facts and circumstances in each case. You can't make up your own definition that every fix-up is a business activity. The facts have to determine that the activity is part of a business activity by or for the owner and not the activity itself. Is the owner in business? Not if he is simply fixing up his personal investment property and not in the business of fixing-up properties.

A code §1221 asset can be held as investment property, improved or fixed-up by the owner (sweat equity and/or outside service), and sold for capital gain reported on 1040 Sch-D. The only other treatment for the sale would be to report it on form 4797 if the asset is used in a trade or business determined by the facts and circumstances. I can think of no circumstance that would properly report the sale gain on 1040 line 21. The bull market has nothing to do with determining anything except maybe fair market value.

Well... your hobby windmills would not be code section 1221 in the hands of the hobbyist as they are produced by him either as held for resale [excluded under §1221(a)(1)] or as a work of art excluded under code section [1221(a)(3)(A)] (see quote below). However, the building he used for his hobby would still be code section 1221 and gain reported on 1040 Sch-D as the building did not change character since it was not used in a business. If I purchased the hobby windmills they would be code sec. 1221 in my hands.

(3) a copyright, a literary, musical, or artistic composition,
a letter or memorandum, or similar property, held by -
(A) a taxpayer whose personal efforts created such property,
(B) in the case of a letter, memorandum, or similar property,
a taxpayer for whom such property was prepared or produced, or
(C) a taxpayer in whose hands the basis of such property is
determined, for purposes of determining gain from a sale or
exchange, in whole or part by reference to the basis of such
property in the hands of a taxpayer described in subparagraph
(A) or (B);