BiggerPockets

Found another one...

Value about 90k, think I can get it for 60k

Basic number:
Rent $1000 - $1200

Expenses: $500
NOI: $500
Mortgage at 6%: $360
Cash flow: $140

Seems to work. My one concern is that I don't expect much appreciation on the unit, not that it is in a bad area, just an older area.

Mike,

Appreciation is useful if you do a cash out re-finance and then use that money to buy more cash flowing rentals. The government doesn't get anything because it's considered a loan. As long as the original property continues to cashflow after the re-fi, it's a win-win situation.

Originally posted by MikeOH

The government doesn't get anything because it's considered a loan.

The government doesn't get any tax because it IS a loan.

Mike

AND, you still owe the tax. For instance, if you take a new loan for, say, $30K, and then later sell the property, you will owe tax on that $30K, even if the proceeds from the sale are zero. Your tax is calculated on the gain, and any loans are not considered.

Not necessarily. If its a rental property, some of that gain would be subject to depreciation recapture tax at 25%.

The point is, however, that gurus often advocate this strategy of doing a cash out refinance to "take your money tax free". Lots and lots of people did that during the bubble. Say your property appreciates from $150K where you bought it to $200K. You bought with 10% down, so you had a $135K loan. Now, at $200K you do a 90% refi for $180K and put $45K in your pocket. Now, you go blow that on vacations and toys. I'll contend that's exactly what most people who did refis or HELOCs during the bubble did. Or, used it for living expenses, which is essentially what the RE gurus were advocating.

OK, you pocketed $45K "tax free". Now, you have to sell. If you really can sell for $200K, you'll net about $184K after taxes, and about $4K after paying off the $180K loan.

But wait, the IRS is there. They see you bought for $150K and sold for $200K. Call it buying for a net of $153K with costs and selling for a net of $184. That's a $31K gain. At 15% LTCG that's $4650 in tax. So, you're out of pocket $650.

What if the price falls, as happened to many people. Say its fallen 10% (pretty modest) off that $200K value. You sell for $180K, and net $166K. You have to bring $14K to the table to sell.

AND, as far as the IRS is concerned, you have a gain (which you really do.) You have a net gain of $13K. So, that's another $2K you have to pay out of pocket.

If it was a rental property, you'd also have the depreciation, which reduced your basis, and the depreciation recapture tax. Say you had held this for five years. You'd have about $22K in depreciation, resulting in $5500 in depreciation recapture tax in any of these scenarios.

Doug,
Wow I am really surprised that you can find anything under 100k in the bay area. Is this out in Vallejo? I left the bay area in the late 90's and property was crazy even then. I was in the east bay and occupancy rates were practically over 100%.... I recall being one of 15 people waiting to see an apartment the first day it was avail, but that was Berkeley/El Cerrito ...

The closer to Bart the better, but I also know that in the 90's lots of companies were moving out of the city and heading toward the Concord area. One thing with the area I was in is that most rentals were turning over fairly often, but the were rented again immediately.