Q: I recently started buying fixer-uppers, renovating them and reselling them for a profit.

This is my first year in business, and I have sold 2 of these homes and will probably have sold a total of 3 by the end of the year. I live in each property as I’m fixing it up. From what I can gather from the IRS publications, I should qualify to pay capital gains tax instead of ordinary income tax since they are also my primary residence. Am I correct?

I have just one more question. When selling the last home that I fixed up, the buyer’s lender requested that I give them copies of all of my receipts for the materials I purchased for the property. Since I was not the one receiving the loan, it seemed like more information than they needed. Is it legal for a lender to request such information from a seller?

I appreciate any advice that you can offer.

A : It seems to me that you might be a bit confused about the IRS rules for a personal residence.

The IRS rules state that you must live in your home as a primary residence for 2 of the past 5 years in order to keep up to $250,000 in profits (if you’re single, up to $500,000 if you’re married) tax free when you sell your home. You may only use this rule once every 24 months.

Given how quickly you are fixing up and selling these homes, my guess is that you do not qualify for the exemption. If you have bought these properties as an investment, and have held onto them for at least a year, you may be able to pay long-term capital gains tax on the profits instead of ordinary income tax.

The publication you should read is IRS Publication 523 “Selling Your Home.” But, I think you’ll really want to talk all this over with the person who does your taxes for you, or a certified public accountant. You could wind up with a significant tax bill next April, and if that’s the case, you’ll want to know about it now – so you have time to plan for it.

As to your other question, the buyer’s lender is trying to determine if you have actually done enough work to the property to justify the increase in price. Con artists will often purchase fixer-upper homes and complete superficial modifications to the home which they then try to pass off as a substantial renovation. Or, they use other schemes to claim an inflated value to a home. These properties are then flipped for a huge profit, scamming the buyer in the process.

The buyers are scammed into believing the property has had a complete gut-job renovation or has an inflated value, when in fact the property has had nothing more than a superficial paint job or has not really increased in value.

I’m not sure whether it is “legal” to ask for this documentation, but if you want your buyer to get his or her loan, I would provide whatever documentation you have. Otherwise, you may wait awhile for another buyer to come along. Your real estate attorney can help guide you as to the local customs in buying and selling properties.

Finally, if you are able to make a successful business out of buying, rehabbing and flipping properties, you may want to talk to your attorney and your tax preparer about whether it makes sense to start a company, which may help clarify your tax and any future liability issues.

Published: Oct 3, 2005