Understanding Flipping Properties: Real Estate Options
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Understanding Flipping Properties: Real Estate Options

The simplest way to flip property without actually taking ownership, and thus avoiding transaction costs, is the real estate option. Real estate options are similar to stock options. With an option, the taxes usually must be taken as ordinary income, since you may not qualify for the one-year wait for long-term capital again.
                    real estate option contract

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Should I do an "option flip"?

The simplest way to flip property without actually taking ownership, and thus avoiding transaction costs, is the real estate option. Real estate options are similar to stock options. For the buyer, you have the opportunity (but not the requirement) to purchase for a set price by some future date. For the seller, you are committed to sell, usually for a set price by a set date. You, the investor, locate the property and make an option offer. If the sellers accept, you next give them option money (perhaps $1,000) and they in exchange give you the right to purchase the property as noted above, usually at a fixed price, for up to certain amount of time, typically no more than six months or a year. Next, you find a rebuyer, someone who will purchase the property from you at a higher price. Finally, you exercise the option at the low fixed price agreed upon by the seller, and then sell to the rebuyer at the new higher price, keeping the difference, which is the profit. In actual practice, all of these moves are made simultaneously and are handled in escrow, and the seller pays the normal seller's closing costs and the rebuyer pays the normal buyer's closing costs with very few transactions costs left for you to pay. The difference is what you pocket. In an option, you the buyer are not committed to purchase. It's at your discretion. The seller, however, is committed to sell, usually at a fixed price. He or she must go through with the transaction if you execute your option.

Do I have to pay taxes on the option profit?

Any time you make a profit, you're going to be liable for taxes. With an option, the taxes usually must be taken as ordinary income, since you may not qualify for the one-year wait for long-term capital again. Check with a good accountant as there are fine points and tricks to the tax situation here.

Do I understand the time problem with options?

Time is the biggest problem with flipping using an option. Typically, options run to six months, although they can be for virtually any length of time. The trouble is that sellers usually want out quickly, and a seller who is will to give you an option of more than 60 days is unlikely to be willing to also give you a good price. On the other hand, if you accept a shorter-term option, you put yourself in a more dangerous position. What happens if you can't find a rebuyer within, for example, 30 days? You lose your option money - and any potential deal.

Do I need a "rebuyer"?

Keep in mind that the key to a successful option flip is to have a rebuyer waiting and ready to go. If you have that rebuyer ready, you can handle a transaction easily in 60 days. Indeed, you might handle it in 30 days, or perhaps even less. But if you have to go out and find a rebuyer once you have the option, time puts a stranglehold on your potential success in the deal.

 

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Comments (1)

An excellent presentation Levy. I didn't know about this option.

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