Is flipping illegal? This is an extremely misunderstood topic among newbie and veteran investors alike. The legality of flipping is swirling with myths and half truths and although I am not an attorney, I will lay out the facts that my experiences have taught me about it.
(Disclaimer: I am not providing legal advice in this article and for such advice on any legal related issues, always consult a qualified attorney.).
If you are (or are considering) flipping property, read this article start to finish. You are probably going to hear things you have never heard before and this may go against the grain of what you may have read or been taught in the past. Flipping property can be extremely profitable but the real estate industry is highly regulated and the participants involved can be quite litigious, so you need to understand what you are getting yourself into, (or what you are already actively participating in).
In order to get to the bottom of this incredibly important question, let's first define what “flipping” is. When you “flip” a property, you get a property under contract for a low price and then resell it to a new buyer for a higher price within a short period of time. In some cases you may add improvements to the property prior to reselling to a new buyer but in other cases, you may not perform any renovations at all and simply assign your interest in the property to another buyer. Is it illegal to buy something at a low price and then resell it for a higher price to someone else?
Some would argue that arbitrage, or the act of buying an item at one price and then reselling the same item at a higher price is Capitalism 101. Some would even goes so far as to say, not only is it legal, but it is the foundation of our economy! So surely it can't be illegal?
Legal pundits will hail the Constitutional right to the free alienation of property as the basis for why flipping is unequivocally legal. Whether you own the property or simply have a contract to purchase it, in either case, you have an equitable interest in the real property and therefore, you supposedly have the constitutional right to resell that interest for a profit. But does this apply in all situations?
Where Flipping May Be Illegal
Despite your Constitutional rights, each individual state has laws pertaining to flipping and some are not as favorable as others. Here are a few examples, although by no means an exhaustive list:
- Washington Law SBH 1843 states that if a person or entity buys real property and intends to renovate it and sell it for a profit and further will be reselling it within 12 months of purchase and, finally, plans to spend more than $500 in renovations, you, or your entity, must be a licensed and bonded general contractor. Notice it doesn't say you have to hire one…it says you have to BE one. Thankfully for Washingtonian investors, becoming a GC is quite easy.
- Washington Law RCW 61.34 stipulates that flipping real property purchased from someone who is behind on mortgage payments and facing foreclosure may be construed as equity skimming and therefore, may be illegal. Although this particular law has more than one interpretation, the consensus among Washingtonian investors is to not engage in purchasing homes from people in pre-foreclosure.
- Maryland Law SB 761 prohibits those who are not licensed real estate agents, attorneys or mortgage brokers from engaging in transactions with people in pre-foreclosure. The consensus among non-licensed investors in Maryland is that flipping foreclosures is dicey at best, and many steer clear of them.
- 90 Day Anti-Flipping Law: This is NOT a law. This is an underwriting stipulation put in place by some mortgage companies and/or certain mortgage loans that require the seller of a property to have been the owner of record for a minimum of 90 days. FHA loans are notorious for this requirement. Even though the ban has been lifted, most mortgage companies that originate FHA loans demand the seller be on title for at least 90 days. Thankfully for wise investors, this 90 day rule is not a big challenge because certain mortgage originators are not required to meet this stipulation. Despite what a mortgage broker may tell you, they are not all created equal and just because one mortgage person must meet the 90 day stipulation, doesn't mean they all must. Many, many investors have fallen victim to having their mortgage broker convince them that they MUST hold onto the property for 90 days before they can resell it. What nonsense!
- Only Licensed Real Estate Agents Can Flip Properties: Every state has laws that describe what real estate income related activities require a license to be legally compliant. Most are very encompassing and can be quite frightening to read, especially if you are a brand new, non-licensed investor looking to get into flipping. Thankfully, most states have an exception to their licensing requirements that sound something like Alaska Sec. 08.88.900: Exceptions. A person who is not licensed under this chapter who manages or makes a real estate transaction with respect to real estate the person owns or is seeking to own so long as the compensation the person receives does not include any portion of the commission or other compensation paid to a real estate licensee in the transaction. The bold emphasis was added by yours truly. Having a contract in place with a seller signifies your intent to own the real property. This is actually an example of state law upholding your Constitutional right to the free alienation of property. However, as you learned in the previous section above, there may be situations, such as when a homeowner is in foreclosure, where you may need some sort of license to flip property.
These are but a few examples of when flipping may be illegal. What others are out there? Please comment at the bottom on any examples from your state so we can all learn and benefit.
Flipping Real Estate Myths
The greater level of freedom of speech expanded by the internet has ushered in a ton of bad and inaccurate information. Here are some flipping myths circling real estate communities across this country that need to be cleared up.
Hopefully this article gave you some clarification and food for thought. But if you are, or want to be, flipping, it would be wise to consult a qualified, local, real estate attorney and ask him/her, “In what situations or scenarios is flipping illegal?”