FLIPPING Flipping is a term used to describe the strategy of buying an asset and quickly reselling (or "flipping") it for a quick profit. Profits from flipping real estate usually come from either buying low and selling high in a rising market, or buying a house in distress and curing the defect. A distressed property isn‟t just a home that needs repairs or fix up – it could also be the seller that is under distress, such as with a short sale or pre-foreclosure. Investors can also flip „paper‟ by assigning contracts that haven‟t closed yet. Whichever way you choose, flipping has high potential for fast profits but as with any investment – there is also risk. The main disadvantages are: The market can go sour and leave you holding your prospective flip You must plan on alternative exit strategies such as renting the property if it fails to sell If you are relying on an assignment, you are also dependent on your buyer to close. If they don‟t, you don‟t make any money. If you are relying on short term funding, your funding may run out before your new buyer closes Because you are holding the property for such a short term - you may be subject to higher tax rates As long as everything goes well, flipping is the ideal strategy for short term profit. However, in the long run, the buy and hold investor has the potential for higher profits than the flipper. For example, let‟s say, a flipper buys a $100,000 property for $60,000. Then quickly resells it for $75,000. They just made a $15,000 profit. With potential tax consequences as high as $5,250, that profit can be reduced to $9,750. Still – a great way to make a fast buck. But, compare that to an investor who buys the same property for $60,000 that is valued at $100,000 and rents for $950 per month. The investor has added $40,000 to their net worth and can also collect income (rent) on the property of nearly $10,000 per year after expenses. If this property is held long term then the value (and the income) should increase over time. The investor also enjoys the tax deductions and as long as the property is not sold, there are no capital gains taxes due. Tax Consequences of Flipping Investment profit, regardless of whether it comes from sale of stocks or real estate, is considered capital gain and is taxed at two levels. The tax rates depend on how long you own the property. If you sell an asset that you held for a year or less you will have short-term gains that are taxed at ordinary income-tax rates. That could be as high as 35 percent. If you hold an asset for more than a year, you pay the long-term capital gains rate that maxes out, in most instances, at 15 percent. There are strategies that may defer or even eliminate your tax bill which include utilizing the 1031 exchange or purchasing through an IRA. A case of Mistaken Identity The term “flipping” with is based on the money making strategy of buying for less and selling for more. Car dealers, grocers, gas stations, and broom salesmen all buy their products wholesale and then turn right around and increase the price and sell them at retail. This practice is considered perfectly legal, in fact, it is pretty much the American Way. So…. what‟s all the fuss about “flipping” when the same strategy is applied to real estate? In the past few years, what has been referred to as “illegal flipping” had nothing to do with buying a distressed property at wholesale value and selling it at market value. The illegal activity should actually be called “mortgage fraud.” Illegal property-flipping scams involve unscrupulous investors who buy properties at wholesale or market value and then falsely inflate the value with the aid of “made to order” appraisals and fraudulent loan documents. To make the scam work, the investor finds a mortgage broker, appraiser, inspector, and realtor and title company greedy for business and willing to “help” the deal along or look the other way. Frequently, these “networks” target the same properties and families that would benefit from the government assisted loans offered through FHA or Fannie Mae. The investor attracts large volumes of buyers by guaranteeing easy qualifying and low or no down payment mortgages. To insure the “network” all get a piece of the pie, the appraiser adjusts the value of the house to whatever price is needed to pay everyone a nice fee. The loan officer may do touch up work on the credit and bank statements or falsify the income verification and tax returns. And, typically, the title company has to make sure the settlement statement doesn‟t raise any red flags. The result is a buyer that paid too much for a house and did not actually qualify for a loan. Within a short period of time, most of these properties are in default. The same programs that are intended to help more families realize the “American Dream” of homeownership are being used by these scammers to line their pockets. They leave the buyer without a home and in credit ruin. Once the house forecloses, the government insured lender is stuck with a property that is worth much less than the loan they paid out. There is no FEDERAL LAW against flipping —There are Mortgage GUIDELINES and Underwriting RULES. Because of all the negative press and added scrutiny, many mortgage companies, title and escrow companies have chosen to steer clear of „flipping‟ and they don‟t want to hold double closings‟. (A double closing is two back-to- back closings where the proceeds from the second closing is used to fund the first closing. Both closings are done in escrow so that the middleman can buy and resell a property for profit without using any of his own money.) There are some companies who still participate in flipping and double closings, however, they require stricter guidelines and more documentation to insure all transactions are above board. CHANGES: FHA and the 90 day rule. In the past few years, FHA would not insure any financing on a property that had already sold within the last 90 days. This timetable required many investors to sit on vacant properties while they seasoned. But as of February 1, 2010, (due to the current glut of foreclosures on the market) FHA released a waiver to their current seasoning guidelines for at least one calendar year. Some restrictions will still apply to ensure that the program is not abused.
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