Is flipping legal? If you are an imaginative real estate investor, or are looking to grow into one, you may be shocked by what you are about to learn. This might even contradict what you have been taught in the past.
In order to get to the bottom of this extremely significant question, let’s first outline what flipping is. When you flip a house, you sign a contract with a seller to purchase their property and then you instantaneously find a new buyer ready to pay more for the property than what you have it under contract for. You then sell the property to the new buyer and profit the variance between what the seller has contracted to sell it for and what the new buyer has arranged to pay for it. In numerous cases, the flipper does not repair or add any enhancements to the home at all. He/she merely gets it under contract for one price and then flips it to another buyer at a higher price tag. Is that legal?
When you’re flipping real estate, what kind of business model are you following? You’re following one of the most common business models in financial history; the wholesale-retail model. For example, look around your house. How did most of your possessions get there? The bulk of those items ended up in your house from the following route. First, the manufacturer produced the item and sold it to a wholesaler. The manufacturer made a profit by charging more for the item than the price to manufacture it. Second, the wholesaler sold that same household good to a retail store for more than what he paid for it from the manufacturer. The wholesaler made its profit by being the middleman; buying low and selling higher. Third, the retail store sold you precisely the same item that they bought from the wholesaler for more than what they paid for it from the wholesaler. The retail store made their profit by being the middleman and buying high and selling higher. Except for the manufacturer, everyone else in the chain made their money buying and re-selling the exact same item for more money to the next purchaser in line. That is the wholesale-retail model in action and it has been used throughout business history.
Is it legal to buy an item at one price and then re-sell that same exact item at a higher price? Are the bulk of businesses operating illegally? The answer is definitely no. So would you assume then that flipping is legal because most industries operate in the same style of buying low and selling a little higher? You may be shocked to hear that real estate is not like most businesses because it is extremely regulated and consequently is not under many of the same commerce laws as most businesses.
DISCLAIMER: I am not an attorney and I am not providing legal advice. On any legal related issues always consult a competent attorney.
When Flipping Might Not be Legal
Flipping might not be legal if state law considers your flipping actions as functioning as a real estate agent minus a license. Certain states have stern laws relating to the earning of revenue from real estate. If your flip deal is done wrong, it has potential to fall into the trap of functioning as a real estate agent minus a license. I’ll bet you didn’t anticipate hearing that!
Maybe some states want to make sure anyone dealing with the executing of real estate have a license to safeguard the community? Maybe the actual motive is to bring in more tax revenue? Whatever the motives, my experiences have been that countless flippers in this country have never read their state’s laws on what activities or actions require a real estate license. And when they do, some may be angered by the result and may even begin complaining about the hazards of big government on our world. In addition to beginning petitions to correct unfair and intrusive legislation, would you like to know how to most safely flip homes?
When Flipping May Be Legal
The safest way to flip real estate is to truly become the owner of record on the property and then resell the house to the new buyer. This can be done by merely recording a Deed signed by the seller so that you (or your LLC or Land Trust) become the certified owner subject to the current financing. Or, the seller may not agree to sign a Deed in the event the home has noteworthy equity or no financing at all. In such cases, you would have to use transactional backing to buy the house with actual money. Then, you would resell the property to the new buyer in a unconnected closing the next day or a few days later. This technique entails two closings which produces double the amount of closing costs. In states like Washington that have tremendously high transfer taxes (fees charged when you record a Deed), those closing costs can totally eliminate a flipper’s earnings. What is a smart flipper to do in such cases?
If you want to escape doing two unconnected closings (as well as all of the closing costs that go along with it), you’ll need to allocate your contract to the new buyer. If you are not a licensed real estate agent, to guarantee this activity is legal, consult a competent, local attorney. Avoid an out-of-state attorney because the legality of flipping is decided on a state, not federal, level.
Even for licensed real estate agents that want to flip by transferring contracts to avoid doing two closings, you must confirm with your Broker if that flip money should go through your Broker or if it can go straight to you. In some states, all real estate commissions must be deposited with your Broker first before being dispersed to you. Flipping profits may be considered a commission and consequently would have to go through your Broker (which may trim 10-30% off your gross earnings due to your Broker’s cut).
In some cases, assigning the contract is not a smart selection for an additional reason; you may not want the seller to find out how much you are earning off the flip. When you assign the contract, your assignment fee shows up on the concluding statement along with the fact that some outsider is in fact the one buying the home. People have some odd psychological mannerisms, including jealousy. One moment, a seller can be elated that you are buying their property for $90,000. The next minute, they find out you are making $10,000 and someone else is buying the property for $100,000 and they get very envious. In some circumstances, the seller will refuse to sell to you. Other times, the seller hires a lawyer to try to get you out of the deal so that the seller can accumulate that additional $10,000. If the seller’s lawyer realizes you are functioning as a real estate agent without a license, you may find yourself in some extremely hot water. Or, the lawyer may merely intimidate you into going away. Either way, the outcome is not what you wanted.
So, doing two closings may not only be for legal protection, but also may be to make sure the deal doesn’t fall apart at the closing. Now and then you sacrifice a small amount in earnings to guarantee you really get the deal closed.
Another route for some is take the time and energy to acquire a real estate license. I’m licensed myself and, after years of fruitfully investing without a license, some of my most prosperous students became licensed as well. It can be a license to print money but it can be a very timely and costly process that has ongoing responsibilities and furthermore, hidden costs. My advice is to get some prosperous investing deals under your belt and make some noteworthy profits before plunging into getting a license. I was a creative investor for 4 years before I got licensed. Once you’ve closed some deals and made some money, think about reinvesting some of those revenues into a license.
Next week we’ll confront another debatable subject…is flipping moral? But for this week, your assignment is to figure out how to flip legally in your state.