Turn a Rental House into Your Home; Then Your Home into a Rental House?
For small fixer upper house investors, like my wife and I, it can pay off big dividends to move into the future rental property that we are repairing. We don’t always do it this way, but we find there are compelling advantages to this technique. These advantages include:
1.) Reduce Financial Strain
We don’t have to make house payments on a property that has no tenants paying rent. In other words, living in the house while we repair it is better than having it empty. If I we live in it, we make the mortgage payment that I would normally have to make anyway. However, if we tried to repair the house, while still living in another house, we have two mortgages to pay, until we can finish repairs on the new house and then rent it out.
This can be a real strain on the budget, especially when repairs go on longer than anticipated. What we like to do is to turn our former home into a rental house and move into the fixer-upper. We usually plan to stay in the new residence anywhere from 6 months to 2 years.
2.) Better Loan Terms
We get better loan terms as an owner occupant. Interest rates on a loan can be one percent lower if we purchase the house as an owner occupant, rather than as an investment property. The less we pay each month during the repair process, the better.
3.) Learn Repair Skills
Instead of rushing through the repair process and having to contract out much of the work, in a more drawn out process we can take the time to learn new repair skills. It also affords us the luxury of being able to make mistakes and learn from them. For me, at least, that is an integral part of the learning process.
4.) Make More Money When Renting
Because of the lower loan terms and lower monthly mortgage payments, when we later rent the property out, we can turn a tidier profit each month. Or, we can make it more attractive to potential tenants by offering to rent it at a lower price.
5.) Accommodates Our 8-5:00 Jobs
Feverishly repairing a new rental property nights and weekends, puts a strain on my wife and I, since we both have day jobs. Stretching out the process reduces the stress level considerably.
6.) Get to Know the House
A slower repair process allows me to really get to know the idiosyncrasies of the house. Later when tenants request repairs, my in-depth knowledge of the house may make these future repairs easier.
7.) Reduce Taxes If We Sell
Although, we believe in the buy-and-hold strategy, if we live in the house for two years and decide to sell, we can sell without paying federal capital gains taxes. If the capital gain is less than $500,000 for couples, the sale of the house is never reported n federal IRS forms.
One Caveat
If you follow this strategy and have a family, expect to live under some primitive circumstances for awhile until you start to get things ship-shape. My kids are thrilled at camping out in a new house, and as long as I get the showers working fairly quickly, my wife is happy. If you take the perspective that it’s an exciting adventure, you won’t be disappointed.
I’d like to share with you a recent question that I received from a reader of my blog. The question was:
“I lived in my primary home for two years and now it’s a rental, can I sell it without paying capital gains?”
My “short” answer is:
That depends on how long the house has been a rental.
No need to push when selling your primary residence
By Way of Background Information
The 1997 Taxpayer Relief Act was a great boost for average people who wanted to sell their home and buy a new one. It was also a great boost for investors. Couples are allowed to exclude up to $500,000 of the capital gain on the sale of their primary residence. Single individuals can exclude up to $250,000.
In other words, the sale of the house is never reported on your federal IRS forms if the capital gain is less than the $500,000 and $250,000 limits.
This exclusion is based on compliance with two requirements:
1.) The home must have been the primary residence for both spouses during two of the last five years. The two years do not have to be consecutive but if you rent out the primary residence for more than three years you would be required to occupy it again for two years.
2.) The exclusion is available only once every two years.
What if you sell you house and your capital gains exceed the established limit?
Capital gains above $250,000 for singles and $500,000 for couples are taxed at the applicable rate.
What if you sell your house before meeting the two year requirement?
The Ideal Strategy for the Pathologically Conservative Investor
Typical conservative investor.
Utilization of this tax exemption is the safest investment strategy for the conservative investor who wants to take few risks. This is the type of investor who wears both suspenders and a belt to hold up his pants. They like to play it really safe.
Under this strategy, the investors can qualify for the least expensive type of loan, the owner-occupied loan. There is no need to worry about tenants destroying your rental property or not paying the rent. You completely control the investment by living in the property yourself. When you sell, you have the opportunity to make up to $500,000 tax-free profit every two years.
So, following that long-winded, yet surprisingly informative, background spiel, my “final” answer to the question is:
If you have lived in your house 2 of the last 5 years, you are entitled to take the exemption.
Coming Soon!
How to Turn Your Home into a Rental House, Instead of Selling It
Are you like me and never socked much money away for retirement? We are not alone. The Employee Benefit Research Institute’s Annual Retirement Confidence Survey found that pre-retirees (Americans between the ages of 55 and 65) greatly underestimate how long they are likely to live and how much money they will need in retirement.
Experts say that we need to change our mindset from “assets” to “income” in retirement planning. It’s not enough to know how much money we have in savings; we need to know how much income our savings can generate over time.
There is no better way to change our mindset and our portfolio from “assets” to “income” than by investing in real estate. If we invest wisely before we retire, and can have a stable of reliable rental properties that generate steady monthly income. We can look forward to a retirement that provides security instead of uncertainty.
Don’t rely on politicians to provide you with retirement security. If you want it done right, you must do it yourself.
I have been the landlord of a triplex for just over 5 years. For most of that time, I simply maintained the property that I owned after making a couple of bigger renovations (windows and insulation). The biggest challenge I had was that my existing tenants paid way below market rent and rent control would not allow me to increase rents beyond 0.7%-2.2% each year. I felt stuck.
Recently, one of those tenants moved out. I managed to gut and redo the one bedroom unit and once it was finished I rented it out for almost double what I was getting before! This took the pressure off quite a bit but I realized I had to get my other “long term” renter out of her apartment. I ended up paying her to leave (2 months free rent) but it looks like it paid off. Her rent for a 2 bedroom was $474.77, but I have a lease now on the apartment for $799 a month. Surprisingly, I got this tenant because they saw pictures of the first unit I did and knew that I was finishing the second unit the same way. When they did the walk through the place was gutted and I didn’t even have the walls framed in yet!
I have looked at some other systems out there, but it seems to me that the only one that really works is finding a run down property with below market rents in a good area, fixing it up, and rerenting to higher classed tenants. If I knew a few years back what I know now, I would get the old tenants out ASAP even if I need to use my “cash for keys” program.
Right now I work full time so I rely on a dependable contractor that I feel I can trust. I hope to start renovating my own houses down the road, but I think I might need to get rid of my job to free up the time. Currently, I just do a walk through each day to see what work has been done and simply manage the renovation. Once the triplex is completely turned around next month I figure I will start looking for another project; I just need to convince my wife who still has fresh memories of my less stellar tenants.
Opening up the old mailbag again, I am printing my response to a recent fixer upper email question that I received.
Hello Terry,
I’m writing you with a somewhat specific question.
I am looking at a house at xxxx Star St. in Duluth, MN. It’s a vacant house (so many are nowdays) and the listing price 39k. Repairs look to be 10.9k plus a fee of 1,100 for re-registering it as occupied.
I walked through the house, visually it’s fine. I like the house, don’t get me wrong. New windows, carpets, paint, etc. But the repairs are mostly plumbing etc. Should I put in my bid for 39k EVEN or throw it down for 29k?
It’s in a fairly low crime area, but across the street is a halfway house for prisoners just getting out into the world…Prior values in the 200k for this area before the Great Collapse….
Thank you for your time,
Malcom
Dear Malcom,
What I see is a red flag that should influence your decision.
The location of the house across the street from a halfway house is going to considerably limit what you can do with the house. Regardless of whether you are going to turn it into a rental or flip it, you have a very limited pool of potential tenants or purchasers. In my opinion, most people would not want to live there.
Consider, if you had a tenant who had a choice to rent your property, or one in another neighborhood nearby that did not have a half-way house across the street. Which would they choose?
Granted, the purchase price is low. However, in my opinion, it’s better to spend a little more money for a house that doesn’t have a glaring defect.
There are a lot of properties on the market right now, and many at bargain basement prices. If I were you, I would consider looking around for another one.
Donald Trump said, “Sometimes your best investments are the ones you don’t make.”
Naturally, people are nervous about making financial changes during a recession. But, refinancing your existing house to take down payment money out of your equity and buy a rental house is one of the safest ways to start investing in real estate. It’s the most common way that real estate investors use to purchase investment properties.
If you have a steady job and a good credit rating, now is a rare opportunity to get a loan in the 4% interest range. And, houses are selling at fire sale prices!
It’s a good idea to refinance a house that you have owned for a few years before reinancing to take some equity out of it.
Refinancing an existing property for downpayment money is a lot better than waiting until you have enough cash to purchase a rental house withouta loan. Having a loan gives you leverage, because you don’t have to use all of your own money, which could take 20 years or more, to save.
The great benefit is, after you have purchased your rental house, is that you have a stream of income that is in addition to your regular 8:00 to 5:00 job.
You can be laid off, or fired from your regular job, but you can never lose your rental property job!
William Nickerson, in his book How I Turned$1,000 into Three Million in Real Estate – in My Spare Time, said “you success with real estate properties is enhanced because you can retain control of it.”
Many people have made money in stocks, but they relinquish control of their money, except when to buy or sell.
When investing in real estate properties, you can retain personal control in all stages of the selection, operation and improvement of your investments. You are the captain of your own ship.
More radio interviews scheduled
Aug. 10, 9:10 am, Dave Kelber will interview me, WRNJ 1510 am Hackettstown, New Jersey.
Aug. 11, 8:10 am, Mark Wayne will interview me, WICH 1310 am, Norwich, Connecticut.
Aug. 17, 6:50 am, Jason Mansmith will host me, WRPN 1600 am, Ripon, Wisconsin
Here is the complete list of my upcoming radio interviews. I will keep you posted as more are added
Aug. 10, 9:10 am, Dave Kelber show, WRNJ 1510 am Hackettstown, New Jersey.
Aug. 11, 8:10 am, Mark Wayne show, WICH 1310 am, Norwich, Connecticut.
August 17, 6:50 am, Jason Mansmith show, WRPN 1600 am, Ripon, Wisconsin.
August 20, 8:30 am, I will be on David Sutton’s show, KSRN 1490 am, Los Alamos, New Mexico.
August 25 at 8:08 am, I will be on Jeff Anderson’s show, KSDR 1480 am, Watertown, South Dakota.
Owning rental houses far exceeds the benefit of the pension that you may receive from your job. I worked for the state of Arizona for 13 years, and I will one day receive a pension of around $1,000 a month.
But, does that really provide security?
Each year the value of my pension will go down because it is not tied to inflation. So, after 10 years I’ll still receive $1,000 a month but because of inflation, it may be actually only worth $100 dollars a month because the cost of my groceries, my clothes, health care, and other costs have all gone up each year.
Rental houses provide a better pension. If I get $1,000 a month in rent profits, it not only keeps up with inflation, but it exceeds inflation.
Which pension program would your rather have? One that increases in value with the passing years, or one that decreases in value?
From: Janet Sent: Friday, June 18, 2010 12:12 PM To: ‘Terry Sprouse Subject: Re:7-Week Fixer-Upper/Rental House Course: Lesson 7
How does the refinancing work in this underwater market? i just bought a house in Jan, do i have to wait 10 years to do this? i am 50 now, should i wait till i am 60 to start doing this? sincerely, Janet
Hi Janet,
That’s a good question.
Everything depends on how long it takes to generate some equity in your house. And, of course, that depends on the situation that the market is in. Right now, as I’m sure you know, housing values are not going up very quickly. In fact, in many areas of the country, housing prices are going down.
So, in your case, all you can do is wait and see what happens. If the housing market improves again, you may be able to refinance sooner rather than later. But, until the equity in your house increases, you would not be able to refinance and buy an investment house.
Best regards,
Terry
———
Usually you need to live in a house several years before you have enough equity to refinance and purchase another house. I lived in my house ten years before I took out the equity to buy my first fixer-upper rental house.
Another possibility it to find a partner with more equity in their house, or who has some cash, and to jointly buy an investment property.
***Warning! Shameless Book Promo Coming Up***
If you are new to investing, make sure you have a good inspection done of your investment property, and follow the safe steps for investing, as I discuss in my new, easy-to-follow guide for beginning investors, “Never Sell Your Home! How to Turn Your Home into a Rental House.”
Buying an investment rental house with the equity from your home is one of the safest and easiest ways to start a reliable new income stream. But, timing and planning are everything.
I wish I had remembered that before I spilled spot remover on my dog, and he disappeared.
But in real estate investing, one of the most basic principals, like the law of gravity, is that you must have some equity in your house before you can take it out and use it.
You can’t rush things, or you’ll wind up with your dreams broken faster than a movie star wannabe, just off the bus from Kansas.
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FIX EM UP RENT EM OUT
Purchase FIX EM UP RENT EM OUT (paperback)Award-Winning Finalist in the Real Estate category of the National Best Books Awards, sponsored by USA Book NewsGreat information for anyone starting out in the fixer-upper business. The author has served his apprenticeship in the trenches.
-- Fixer Jay P. DeCima, Investor and AuthorTerry Sprouse has created a profitable rental business in his spare time. What sets him apart is he took action.-- Bob Zachmeier, Investor, Educator, Author With the wit of Will Rogers, this book provides simple guidelines for restoring homes, and sanity to our crazy lives. --M.D. Matlock, Ph.D., P.E., C.S.E.
