Officers say they received a report from a passerby on Monday afternoon, and arrived at the flat on Fife Street in the evening to arrest the man.
They subsequently removed the flag, which showed the slogan both in Chinese and English.
The man was being investigated by the Mong Kok district crime squad and remained in detention on Tuesday.
The crime of uttering seditious words is part of a rarely-used colonial-era law which can see first-time offenders jailed for up to two years and fined HK$5,000.
Prosecutors have used the law to charge People Power activist Tam Tak-chi, accusing him of chanting seditious slogans that incited hatred and contempt of the Hong Kong government.
He has been remanded in custody since last September, pending trial.
Meanwhile, a 24-year-old man, Tong Ying-kit, is to face trial on Wednesday for allegedly flying a flag with the same slogan while driving his motorbike on July 1, 2020. He is also accused of driving into a crowd of police officers.
Tong will be the first person to face a national security trial since the legislation came into effect almost a year ago.