Who Do You Work For?
The answer may surprise you, especially if you are self-employed.
I’ve recently posted a series of blog and Facebook posts describing how it is getting harder to make money renovating and reselling houses. I’m not complaining. You just have to be aware of the market conditions to survive in this business.
“Flipping” is generally construed to mean completing the buy-renovate-sell process in less than a year. Some say in less than 9 months. Today, I want to explain why “flipping” houses is less profitable than renovating and holding them. And that explanation derives in part from who I want to work for.
I’m going to take one of the projects we did last year and show you how we could have dramatically increased the amount of money it put in our pockets. Since it’s impossible to handle the same deal two different ways, the numbers I’m presenting are projections based on the reality of the deal.
In the example shown in the upper right cal-lout, the after-tax profit generated by holding and renting the property for a year is 152% of the profit generated by a straight flip.
In both cases, I assumed financing $150,000 at 12% APR, but I didn’t include any interest income or savings from the unused portion of the loan. The initial reno to get the house rent-ready was $10,000, but in both cases, the total renovation was $68,000. This ignores the fact that you would have to touch up some wear and tear on the house after renting it for a year. It also ignores that there would probably be some inflation on labor and materials for the final renovation after the tenants move out. These omissions are more than offset by assuming the same final sales price. In our market, the house would usually be worth between 5% and 25% more after a year. In a downturn, we would simply hold and rent the house through the trough.
The difference in profit comes from tax savings. The house generates $12,000 income during the rental year. Almost all of the tax on that income is offset by interest, property taxes, and depreciation.
But the real difference in tax expense comes at sale. Why are the rental taxes so much lower? By holding the property for more than a year (1 year rental plus renovation time), you move the income from regular income (28% to 39.6% in 2017) to capital gains (15% to 20%).
Want to save even more on your taxes? Hold the property at least two years and exchange it for up to three more properties totalling equal or greater value. The IRS code defines the terms of the exchange. For a simpler explanation, see Wikipedia.
Now, being a landlord isn’t for everyone. If you’re tired of managing your rental properties, let us know. We love rental properties, and we’re always willing to see if we can make your life easier by taking an unhappy rental off your hands. You can reach us at 512-807-8777!