As I’m writing this post, it’s been exactly a year since I posted our eight exit strategies. You may notice there are nine thought balloons around the house in the graphic. I’ll get to that later.
Exit strategies are simply plans to get out of your situation. When I was writing on tax day, I got to thinking about how our tax situation affects which exit strategy on any given deal or series of deals. That’s what caused me to add the ninth strategy to the list.
- Walk Away or Refer
There is no real tax consequence for walking away from a deal or referring it to a Realtor® or maybe even another rehabber whose model fits the deal better. You don’t make any money on the deal, at least not directly. So you don’t have to pay taxes on what you don’t make. You can build relationships, but those aren’t taxable either.
Wholesaling is where you sell your contract to buy a house without ever taking title to the house. You can usually make a few thousand dollars on this type of transaction. That money is short-term capital gains and treated as ordinary income, which can be taxed up to almost 40%.
- Double Close
You would double close when you have to take title but don’t really do any work on the house. It is more expensive that wholesaling, so, as a rule, double close only when you don’t want one or more of the parties to know how much you’re making—for example, more than $10,000. Again this income is taxed as ordinary income, the highest tax category.
A prehab is a double-close where you spend a little money. Not much—usually you don’t do more than haul off the garbage from a hoarder house or other cleaning and painting. You can make a good penny on a prehab, but it is still taxes as ordinary income.
A rehab is the type of deal you see on any of the flipping shows on TV. Depending on the duration of the project, the money you make from a rehab is usually ordinary income. Some of our jobs have lasted more than a year for various reasons. On these longer term projects, profits become long-term capital gains, and that can reduce your tax burden significantly. In 2017, the maximum capital gains rate for depreciable real estate is 25%, down from a maximum income tax rate of roughly 40%. That reduces your tax burden from $400 to $250 per $1,000 earned.
- Hold and Rent
If you opt to hold and rent the property, you can refinance it, getting up to 75% of the after repair value (ARV) in a untaxed income. There are no taxes on money you borrow. However, you do have to pay income tax on the rental income, but that is offset by depreciation, repairs and maintenance, commissions, and other expenses. Depreciation does reduce your basis and, therefore, increases your taxable profits when you sell the property, but that’s on down the road. In the mean time you get to enjoy at least four wealth building strategies through rentals.
- Owner Finance
Owner financing a property you sell is like renting it from a cashflow perspective, but you don’t have to worry about maintenance, property taxes, and homeowners’ associations.You can treat the sale as an “installment sale,” which means you only pay taxes on the interest you earn and the portion of the principal the buyers pay down every year.There is a hybrid strategy called the Assignment of Mortgage Payments System (AMPS). This is where you wholesale a subject-to property to a retail buyer and owner finance the difference between the underlying mortgage and your sale price to the new purchaser.
We’ve done a few posts about “homestead flips,” and we’re working on a couple of them. So I decided to add it to our list of exit strategies. The short version is that if you live in a home as your primary residence for two years, the sale of that home may be treated as a “non-taxable event.” In 2017, the maximum sale price to qualify is $250,000 for a single couple or $500,000 for a married couple.
I never enter into a contract on a house unless I have two viable exit strategies, not counting the first two, which are constant. If we can’t realistically make money with two or more exit strategies, the deal is probably too risky. I either walk away or refer it to a Realtor or someone else.Hermann says please like and share!