Be Careful that Your Fix-n-Flip Doesn’t Turn Into a Flippin’ Fail

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I’m still thinking about all the pearls of wisdom I got from yesterday’s FREE! teleseminar call with Joe White. If you didn’t get a chance to join us for Sat AM’s call, please check at DKTeleseminars over the next few days, we’ll get it posted there to listen again for a small handling fee.

I have a client couple that is buying cheap houses in the Midwest (low 5 figure purchase prices), fixing them up and then reselling them for profit. They’re making an average of about $20,000 per month. Great money!

Joe and I talked a bit about the fix-n-flip strategy. In most markets, it’s a dangerous strategy from a financial standpoint. In a sec, I’ll tell you about why it’s not a good strategy for taxes either, but first here are Joe’s concerns that he expressed.

First, you have just bought something with the idea that you can sell it for more. In today’s crazy economy, there is just too much volatility. It’s like the normal rules have been thrown out the window. What you pay today may be more still then you’ll pay in a few weeks. And this is true even if there is no outside reason for the decline. The issue is “perception as reality.” Joe recounted the stories he’s seen of people in his Colorado market, which has not been hit by the slump, who are dumping houses right and left. Why? Because they watch the west and east coast news and see the doom and gloom. If it’s bad on TV, it must be bad here. Perception becomes reality. So, they dump the real estate before it can become bad and thus ensure that the real estate DOES become bad. Strange phenomenon, but true.

Second, even if you can get financing (and chances are you can’t), how can you find a buyer who can? A jump up in value is the kiss of death on an appraisal these days. Chances are you’re going to have to do seller financing to sell it. And that will work as long as you can afford to carry your buyer. In other words, you have a lot of cash to make the deal work. But if you have that kind of liquidity, there are much better, much bigger markets to tackle then the little fix-n-flip market.

Third, many people are buying real estate now for generational investing. Prices are the lowest they’ve been in decades. I can’t tell you when it will turn, no one can. But you know that it will within your child’s lifetime. That means that there is a big gain possible, but only if you view real estate as a long term investment. And that rules out the fix-n-flip.

Now, here is my main tax issue: The fix-n-flip is at best a business and that means self-employment tax. Watch out that you don’t do this in the wrong business structure, or worse yet, no business structure. You could get stuck paying an extra 15.3% in tax.

And what if you end up getting stuck with the property through a calendar year end? You are a developer. That means you can NOT take a deduction for any of the improvements, depreciation or even the mortgage interest or property tax. As a developer, all of that must be capitalized into the property as a cost basis until the day you sell.

Be careful if you are using the fix-n-flip. It could turn into a flippin’ failure.

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