How to Pay Yourself When Flipping Houses

Flipping houses can be profitable, but determining how to pay yourself requires careful planning. Unlike traditional jobs with set salaries, house flippers must navigate fluctuating profits, business expenses, and tax considerations. Taking too much too soon can strain cash flow, while waiting until the end of a project may not be practical for covering personal expenses.

Managing income effectively involves understanding costs, calculating net profit, and selecting a payment method that balances liquidity and tax efficiency. Proper documentation and awareness of tax obligations help avoid financial pitfalls.

Cost Analysis

A thorough understanding of expenses is necessary to determine available profit. Costs extend beyond the purchase price and renovations—holding costs, financing fees, permits, insurance, and unexpected repairs all impact the bottom line.

Financing costs can be particularly significant, especially with hard money loans or private lenders. Interest rates typically range from 8% to 15% annually, with origination fees adding another 1% to 5%. Delays increase these costs, cutting into earnings. Property taxes also vary by location, with rates exceeding 2% in Texas but falling below 0.5% in Hawaii.

Unexpected expenses such as structural issues, code violations, or market downturns can disrupt financial planning. A contingency budget, usually 10% to 20% of the renovation estimate, helps mitigate these risks. Without this buffer, unexpected repairs could force additional borrowing, increasing interest expenses.

Net Profit Calculation

Net profit is determined by subtracting all direct and indirect costs from the final sale price. Beyond the purchase price and renovation costs, deductions include closing costs, agent commissions, marketing expenses, and taxes.

Real estate agent commissions typically range from 5% to 6% of the sale price, meaning a $300,000 home could incur $15,000 to $18,000 in fees. Closing costs—such as title insurance, escrow fees, and transfer taxes—can add another 2% to 5%. Marketing efforts like professional staging and photography may also be necessary to attract buyers.

Depreciation recapture is another consideration if the property was previously used as a rental. Under IRS rules, any depreciation claimed must be repaid upon sale, taxed at a rate of up to 25%. If $10,000 in depreciation was taken, this could result in a $2,500 tax liability. Understanding these obligations helps prevent unexpected reductions in profit.

Compensation Methods

Once net profit is determined, deciding how to pay yourself depends on business structure and tax considerations. The three primary methods are direct withdrawals, scheduled payroll, and distributions. Each has advantages and drawbacks depending on cash flow needs and tax efficiency.

Direct Withdrawals

For sole proprietors and single-member LLCs, direct withdrawals—also known as owner’s draws—offer a simple way to access profits. Since these entities are pass-through businesses, income is reported on the owner’s personal tax return, and withdrawals are not subject to payroll taxes. However, self-employment tax applies, covering both the employer and employee portions of Social Security and Medicare, totaling 15.3% under IRS rules.

A common mistake is withdrawing funds before ensuring all project expenses are covered. If unexpected costs arise, additional capital may be needed, potentially requiring high-interest borrowing. To avoid this, many flippers set a percentage-based withdrawal limit, such as 30% of projected net profit, until the property sells. This approach helps maintain liquidity while still allowing for personal income.

Scheduled Payroll

For house flippers operating under an S-corporation or C-corporation, paying themselves a salary through scheduled payroll can provide tax advantages. The IRS requires S-corporation owners who actively work in the business to take “reasonable compensation” before receiving distributions. This prevents avoiding payroll taxes entirely by only taking dividends.

Payroll wages are subject to federal income tax withholding, Social Security, and Medicare, but they also allow for more predictable personal income. Additionally, salaries are deductible business expenses, reducing taxable corporate income. However, payroll taxes add costs, with employers responsible for 7.65% in Social Security and Medicare contributions, plus potential state unemployment taxes.

To determine a reasonable salary, flippers often benchmark against industry standards. For example, if a general contractor in the area earns $60,000 annually, an active house flipper performing similar work may need to set a comparable salary to comply with IRS guidelines.

Distributions

For multi-member LLCs and S-corporations, distributions allow income withdrawals without incurring payroll taxes. Unlike wages, distributions are not subject to Social Security and Medicare taxes, making them a tax-efficient option. However, S-corporation owners must first pay themselves a reasonable salary before taking distributions to avoid IRS scrutiny.

LLC members typically receive distributions based on their ownership percentage, as outlined in the operating agreement. If two partners each own 50% of an LLC, they would split profits accordingly. Distributions can be taken periodically or as a lump sum after a flip is completed.

One risk with distributions is that they depend entirely on available profits. If a project runs over budget or sells for less than expected, there may be little to distribute. Some flippers reinvest a portion of earnings into future projects, ensuring ongoing cash flow rather than relying solely on one-time payouts.

Documentation Guidelines

Accurate financial records are essential for tracking income, managing cash flow, and ensuring compliance with legal and accounting standards. Every transaction related to a house flip should be meticulously documented, from acquisition costs to final sale receipts.

A dedicated accounting system helps maintain organization. Software like QuickBooks, Xero, or specialized real estate management platforms can categorize expenses, generate financial statements, and track profitability per project. Separating business and personal finances by maintaining a dedicated business bank account and credit card reduces errors and ensures all transactions are properly accounted for.

Detailed bookkeeping should include invoices, receipts, contractor agreements, and lien waivers. Failure to track payments to subcontractors can lead to disputes or even mechanic’s liens, which can delay the sale of the property. Additionally, maintaining updated balance sheets and profit and loss statements helps flippers assess financial health and make informed decisions on future projects.

Tax Implications

How you pay yourself from house flipping directly affects tax liability. The IRS treats house flipping as active income rather than passive investment income, meaning profits are subject to ordinary income tax rates rather than the lower capital gains rates. Business structure determines whether earnings are subject to self-employment taxes, payroll taxes, or corporate taxation.

For sole proprietors and single-member LLCs, all profits from flipping are taxed as ordinary income and reported on Schedule C of the individual tax return. This means earnings are subject to both federal income tax and self-employment tax, which covers Social Security and Medicare at a combined rate of 15.3%. If net earnings exceed $200,000 for single filers or $250,000 for married couples, an additional 0.9% Medicare surtax applies. To reduce taxable income, flippers can deduct legitimate business expenses, including materials, contractor payments, and marketing costs, but must maintain proper documentation to substantiate deductions in case of an IRS audit.

S-corporations offer a way to reduce self-employment tax liability by splitting income between salary and distributions. While wages are subject to payroll taxes, distributions are not, potentially lowering overall tax burdens. However, the IRS mandates that owners pay themselves a reasonable salary before taking distributions, and failure to do so can trigger penalties. C-corporations, on the other hand, face double taxation—once at the corporate level (currently 21%) and again when dividends are distributed to shareholders. Some flippers mitigate this by reinvesting profits into future projects rather than taking large payouts.