Are you considering buying residential properties, improving them, and selling them for profit? This is a common real estate investment strategy known as house flipping, and according to ATTOM, approximately 67,817 single-family homes and condominiums were flipped in the U.S. alone in the first quarter of 2024.
House flipping is a profitable business model with high demand. However, the housing market tends to be strictly regulated, which means there are several potential legal pitfalls to be aware of.
If you are a would-be house flipper, this article would be a great place to get started. We will explore some of the most important laws you will need to keep in mind and how to safely navigate the legal risks you might face. Let us dive in!
Potential Legal Risks Every House Flipper Should Know
There are numerous potential risks involved in any real estate transaction; however, when it comes to house flipping, these are some of the most common risks to watch out for:
1. Title Fraud
One of the most important things to do when purchasing any property is to perform a title history search to be certain who holds legal title to the property and whether there are competing claims to it.
As Jeffrey Zhou, CEO and Founder of Fig Loans, explains, “One of the quickest ways to throw your money down the drain or get caught up in unending legal battles would be to invest in a property with uncertain legal title. In simpler terms, you need to make certain to purchase any properties from the rightful legal owner.”
While this may sound like a no-brainer, establishing that the purported owner of a property is the legally recognized holder of the title to that property can be complicated. For example, properties with liens or outstanding tax debts are a major risk for any purchaser as they may lose this property or incur significant financial costs down the line.
In addition to performing detailed title searches as we have recommended, you can also invest in title insurance to protect your investment if things go south.
2. Mortgage Fraud
Fraud in real estate transactions is an increasing problem. Unfortunately, it can take on numerous forms, making it essential for investors to be vigilant. One of the more common risks to watch out for is mortgage fraud.
Chris Aubeeluck, Head of Sales and Marketing at Osbornes Law, offers the following insight, “In many cases, potential buyers look to finance their new homes with mortgages and may provide misleading or outrightly false information in order to get larger loans. This creates a significant amount of risk for anyone looking to flip homes, as they may then get caught up in any ensuing legal battle.”
Again, taking out title insurance is a helpful practice that would provide some protection against such risks. You should also consider seeking the help of a reputable real estate professional or lawyer who may be more experienced at detecting business fraud.
3. Anti-Flipping Rules
Most countries like the U.S. and Canada aim to protect the needs of the housing market by preventing or limiting speculative investments like house flipping. In practice, these rules usually take shape in the form of higher taxes and other regulations that may erode your profits or render your house flipping illegal.
Anti-flipping laws tend to be specific to local government areas (like counties in the U.S. or municipal areas in Canada), so be sure to look up the applicable regulations in the area you would like to buy and flip in.
Additionally, there are usually some tax implications to be aware of. When you resell a home within a year of purchasing it, with a few exceptions, the proceeds will usually be considered business income and will be taxed accordingly.
As Jonathan Feniak, General Counsel at LLC Attorney, advises, “First-time home flippers are often caught by surprise by how much they have to pay in taxes. If you are considering the home-flipping investment model, you will need to think very carefully about the tax implications.”
In addition to things like business income tax, consider how property improvements might increase your property tax liability. Boosting your home’s curb appeal is a clever way to increase its value, but this will also mean potentially increasing the amount of property tax that you’ll need to pay.
For the best results in selling a flipped property, these tips for selling rental properties will come in handy.
4. Fair Housing Laws
Most countries have fair housing laws that are designed to eliminate discrimination. For example, these laws may require that you put out demographically neutral advertisements to eliminate the potential for bias in your selling or renting decisions.
While you may not have any such prejudices, you could easily run afoul of such laws if you do not take care to ensure strict compliance with them. For instance, a house-flipper may have legitimate concerns over the damage a large family with young children could do to their property. However, refusing to sell or rent to a family for those reasons would violate fair housing laws in most places.
5. Contractual Disputes
House flipping will typically require that you enter into multiple contracts. You will eventually have contracts with a seller and a buyer, as well as with building contractors. If you are financing your investment through debt, you will also need to think about other parties, such as your financial institution. This means that the potential for legal liability is often quite high.
Speaking on these potential risks, Alan Parkes, Owner of Denver Roofing & Colorado Springs Roofing had this to say: “Many people may underestimate the extent of the contractual obligations they may incur when they set about a building project. Breaches can escalate into legal battles, potentially resulting in liens, payment disputes, or even the buyer exercising their right of rescission, which could jeopardize the entire deal.”
6. Environmental Hazards
When selling property, you will typically be required to make disclosures about any environmental and health hazards that exist on the property. For instance, you may discover lead paint or asbestos during a renovation.
A failure to disclose these hazards to potential buyers could lead to legal liability. Additionally, the removal of these hazardous materials is usually costly and time-consuming.
For a comprehensive list, you should consult with a lawyer or be sure to study the applicable laws for your county or municipal area.
7. Building Codes and Zoning Rules
Most counties or municipal areas have extremely specific regulations that govern the sorts of building activity you can undertake in specific areas. These regulations can be so specific that even relatively moderate improvements to the building’s structure or use may flout them.
For instance, purchasing a property zoned for residential use but converting it into a short-term rental may require specific permits, without which you may be held to have violated zoning laws.
Final Word
House flipping can be a lucrative venture, but it is essential to approach it with caution and a thorough understanding of the legal landscape. While the advice we have provided will certainly help you get started on the right footing, we would also strongly recommend that you consult with legal and real estate professionals whose expertise may save you from costly mistakes. If you’ve enjoyed reading this article, we’d recommend learning what counts as debt when applying for a mortgage.
