“I owe how much?”
I blinked at my accountant. She blinked back. She slid the papers to me like they were a secret. I looked them over and promptly slid them back.
“There’s no way,” I said.
She shrugged, “Taxes.”
It was years ago when I had just completed my first flip in California. I bought a property for $125,000, sold it for $210,000, and incurred a lot of costs in between. I’d spent $60,000 on the flip, leaving me a mere $25,000 in profit. That wasn’t a lot, considering that the flip took me half a year to finish.
And then I discovered I owed nearly $10,000 in income taxes, too.
California: The Land of Opportunity (and Taxes)
Everyone knows California is the land of high taxes. It was a lesson I learned quite abruptly—and one I’ll never forget.
As you embark upon your investment career, you’ll find it prudent to factor taxes into every aspect of your business. And there are strategies that you can take to protect your ROI. One of them is being aware of the current investment landscape.
Right now, California citizens and lawmakers are hard at work trying to make real estate more affordable. But the reality is that California real estate is expensive because California is a great place to live. In many sectors, the economy is booming. And the weather? Always great.
So, some lawmakers are trying to introduce certain measures and controls—such as increased taxes for real estate investors. These taxes would make it harder for investors to make a profit, but not necessarily impossible. By educating yourself regarding current (and future) tax measures, you can protect your ROI.
Here’s what you need to know about flipping houses in California and taxes.
What is the California Housing Speculation Act (AB 1771)?
In February 2022, lawmakers introduced the California Housing Speculation Act as a potential method of slowing down the California real estate market. The California Housing Speculation Act (AB 1771) imposes a tax of up to 25% on an investor’s net capital gain should they sell a house within three years.
AB 1771 was denied a vote and will not be introduced into law this year, but it still highlights some challenges that investors, including house flippers, may face in the future.
California Housing Speculation Act (AB 1771)
“This bill would, for taxable years beginning on or after January 1, 2023, impose an additional 25% tax on that portion of a qualified taxpayer’s net capital gain from the sale or exchange of a qualified asset, as defined. The bill would reduce those taxes depending on how many years has passed since the qualified taxpayer’s initial purchase of the qualified asset. The bill would create the Speculation Recapture Community Reinvestment Fund and would deposit the revenues received as a result of this increase in tax in the fund. The bill would require the Franchise Tax Board, upon appropriation by the Legislature, to allocate moneys in the fund, as described…”
Opponents of AB 1771 believe that it’s misguided. They think investors who purchase houses and sell them within a few months are revitalizing the market. They are purchasing and updating run-down houses that cannot be otherwise lived in, thereby bringing housing stock into the market. If anything, they are helping to keep rental prices more affordable.
Flipping Houses in California: Taxes and ROI
If you’re flipping houses in California as a business, you will pay income taxes on your profits. You pay income taxes based on your income bracket, so there isn’t a static number—but it generally averages a little over 20%.
Additionally, you’ll pay self-employment taxes because you’re your own business. These usually add another 15% on top of your other taxes. So, you could find yourself (like me) paying nearly 35% of your income in taxes.
Now, if you’re smarter than me, you’ll have already calculated that into your ROI.
State income taxes in California range from 1% to 12% and can also take off a huge chunk of change from your earnings. If you make $100,000 in profits in California, $15,009 will go to the federal government, and another $9,813 will go to the state. Here’s what your net income would look like:
|Tax Breakdown for $100,000 in Income (Estimated)|
|Federal – Marginal Tax Rate||24%|
|Federal – Effective Tax Rate||15.01%|
|Federal – Income Tax||$15,009|
|California – Marginal Tax Rate||10.30%|
|California – Effective Tax Rate||9.81%|
|California – State Tax||$9,813|
|Total Income Tax||$24,822|
|Income After Taxes||$75,178|
And, as mentioned before, the state wants to make that amount higher for real estate investors. But what does that mean for house flippers in particular?
Strategies to Protect Your ROI When Flipping Houses in California
When flipping houses in California, you have to be more conscientious than ever about your budget. With California’s taxes added to the mix, you must make sure you’re choosing suitable properties to invest in.
Follow these strategies to shield your ROI from taxes:
- Live in the house. If you’re doing one or two flips a year, consider making one house your primary residence. It’s a great way to start flipping, but it’s not a long-term solution. When you make a house your primary home, you pay less in taxes when you sell it.
- Track all your expenses. You may not be making as much as you think. If you’re booking $50,000 in profits, you might not consider an extra $4,000 or $5,000 in expenses a big deal. But that’s a lot when it comes to your taxes.
- Avoid overpaying. There are a lot of rules that investors follow to calculate how much they can pay. Some tools can help you estimate how much a property is worth.
Ultimately, the strategies that will protect you from taxes are the same ones that will help you build ROI. Never leave money on the table, and reduce any expenses you can while booking the ones you can’t avoid.
Why AB 1771 Won’t Pass This Year
Realistically speaking, AB 1771 may never pass because it’s not very popular. But even if it did, house flippers would still find ways to protect their ROI. People move into the California market because many areas in the state are flourishing.
Yes, you’ll pay a lot in taxes, but you shouldn’t let that scare you off. After all, paying taxes means that you’re making a profit. Regardless of the state, you will never pay more in income taxes than you earn.
Protect Your ROI with HomeVestors®
If I had become an independently owned and operated HomeVestors® franchise owner from the start, I would have known about those pesky California taxes. That’s because HomeVestors® has a massive amount of resources for investors, including one-on-one mentorship and direct networking opportunities. They’lll give you the support you need, whether you’re a newbie or a seasoned professional.
With HomeVestors®, you can:
- Get the right financing through the company’s very own lending portal.
- Calculate how much a property may be worth with the proprietary ValueChek™ tool.
- Reduce your marketing spend by getting leads that come directly to you.
- Connect with other real estate investors to learn tricks of the trade.
If you’re flipping houses in California, taxes will always be at the top of your mind. But you can protect your ROI if you have all your ducks in a row.
Take the next step on your real estate journey and learn more about flipping houses in California by contacting HomeVestors® today.
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