House Flipping Accounting

I have 2 clients who buy homes, fix them and sell them 3-12 months projects.  One Clint, categorizes the purchased property as Building (amount of purchase) and under other assets all the expenses that go with the rebuilding, utilities, taxes, etc.  The other client, categorizes the properties purchased as Other Cu rent Assets, and the expenses under Cost of Good Sold. Which is correct? Are both correct..if so why do one instead of the other?  Thanks.

Answer

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Most house flippers are considered dealers by the IRS. The IRS does not look at any one circumstance in making its determination, but a good rule of thumb may be to look at the intent when the property was purchased.

  • If the property was purchased with the intent of fixing it up and turning around and selling it, then the flipper is most likely a dealer.
  • If the property was purchased with the intent of holding on to it long term in hopes the property will appreciate in value, then that person is more likely an investor.

Other things that may be considered in determining dealer or investor are: duration of ownership, extent of improvements, time and effort spent on doing or supervising improvements, time and effort devoted to the sale.

A house flipper (dealer) would record all costs for the acquisition, fixing up, and sale related to the property in a work-in-progress account (WIP). The WIP account is akin to an inventory account and is a current asset. Most flippers turn the property around in less than a year. ALL costs related to the property are included in the WIP account, e.g. employee wages, taxes, insurance, and use of other business assets. You will not take those costs as an expense.

When the property is sold, you will close the WIP account to cost of goods sold and record the sale as ordinary income. If the property owner is a dealer, their sale would be ordinary income (Schedule C for a sole proprietor). An investor would report the sale of a capital asset.


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