The Pros and Cons of Flipping Houses
Have you ever dreamed of being the next Chip and Joanna Gaines? I know I have. I love the idea of taking a dilapidated house in need of some love and transforming it into a beautiful, lively home. When that entire process is reduced to an hour to fit a television schedule, and the ending is always a good one, it really doesn't seem so hard, right?
If you’ve ever thought about venturing into the world of flipping houses, make sure you know the potential risks and rewards before you get started. There certainly can be major benefits, but there can also be significant risks that you want to be prepared for.
- Potential to make a quick profit – The house-flipping business can be lucrative, especially for professionals who do it full-time. You can make a substantial profit in a relatively short amount of time, often making upwards of the average U.S. median salary, and sometimes within just a few months.
- Personal development – You can gain further education in a variety of areas such as construction, the local market, negotiating and financing. You’ll also increase your network by working with attorneys, realtors, contractors, insurance brokers and inspectors, which could always benefit you in future investment opportunities.
- A rewarding experience – There’s a sense of personal accomplishment and satisfaction that can come from seeing the potential in an underappreciated property and then seeing that potential come to life. You can feel a great deal of pride in knowing you’ve not only created value in something that you’ve poured your blood, sweat, and tears into, but you’ve also achieved financial returns far superior to other investments available to the average person.
- Potential to lose a lot of money – Just as you have great potential to win, you also have great potential to lose. Many factors can contribute to this loss such as unanticipated expenses, the potential for higher carrying costs if you can’t find a buyer, losing your profit to capital gains taxes and a shift in the market.
- Short-term capital gains tax and ineligibility for 1031 Exchange – If you flip a house you’ve owned for less than one year, you’ll miss out on the low tax rate offered by the IRS for long-term capital gains. Instead, you’ll face short-term capital gains which are taxed at your regular marginal income tax rate. In addition, one of the benefits of real estate ownership is the ability to do a tax-deferred exchange when you sell an investment property, which allows you to avoid paying capital gains taxes as long as you reinvest the proceeds in another property. However, you can only file with investment property, which means flipped properties frequently don’t qualify because they’re typically speculative and short-term. One option would be to flip a house and then rent it out for a year or two before you sell.
- Stress – While the idea of transforming a house or building can be fun, it can also be quite stressful. It’s easy to get in way over your head if you’re unprepared or ill-equipped to deal with the unexpected challenges, time commitment and cash flow necessary. It takes a lot of knowledge and skill to succeed, not to mention money, time and patience.
Flipping property is a riskier type of investment, and like all riskier investments, the reward can be great, but the fall can be greater. It’s important to go into the venture with realistic expectations of what’s involved. Seek out professional advice, or even find a mentor. You’ll need to make sure you have plenty of money saved as you’ll need a lot of capital up front, with no guarantee of when or if you’ll see that money again.