What's the next move? Needing advice...

17 Replies

Hi Everyone,

Would love some advice from those of you who have been in my shoes before. I'm new to this and cramming education quickly. Im a young corporate sales professional with a large income (which we all know means "taxed to death" lol ) only a small mortgage and a car payment for debt. In July of last year I purchased a home out of state where my parents live so they could remodel it (which is their specialty and darn good at it) I needed the tax write off desperately and every mentor said it was a must. Why I didn't buy a primary home is because San Diego is mad expensive and I'd rather use my debt to income ratio on rentals or flips rather than a 500k mortgage.

After learning more about REI, I now want to work my way to changing my income source. So what's the next move?

I bought the home in Coeur D Alene ID  for 15k under asking price, 20% down, put about 10k in materials and 20k of labor -rough numbers as I'm still tallying up everything- Come July the status of the home is eligible to change from being second home to whatever I want and I'm researching whether or not to sell it, rent it or hold it longer. I'd rather utilize the investment for cash flow as I'm currently paying the mortgage on top of the rent I pay here in SD. It's tough to completely say without knowing my specifics and lifestyle, so I completely understand not getting straight forward advice. I expect to make a similar income this year and need a write off while I'm still a wage earner.

Should I sell the place, do a 1031 and purchase a MF for cashflow or another flip? Just hold on to it, continue paying the mortgage until I have a larger amount of capital to do a proper investment? I'm ready to start taking some risks and create cashflow :)  Thanks all! 

Hey Elle,

What a great position to be in; this site is full of people who have quit their full time job through REI, so you've come to the right place.

I'll point you to a couple resources, but I think the answer to your question is to do what you enjoy most.  If it's flips, do those!  Figure out how many you need to do in a year to quit your job and put together a plan to get it done.  If it's land-lording and providing great places for people to live, then do that!

That being said, there's a few podcasts that I hope will be helpful for you:

http://www.biggerpockets.com/renewsblog/2015/04/02...

http://www.biggerpockets.com/renewsblog/2015/03/26...

http://www.biggerpockets.com/renewsblog/2015/03/12...

I hope you find those informative. I started REI full time in the fall and I'm loving it!

@Andrew Davis thank you so much for the encouragement, advice and links! Can't wait to be in it full time and helping others in the process :)

Here's to your current and future success!
Elle

Hi Elle,

There are so many numbers that need to be addressed to answer your question. I think you need to have a long talk with your tax accountant for the answer. Have you talked to a property manager? I can send you a list of PMs in town to interview. They will look at your property and give you a rental price as a good will gesture. Are you going to self manage or hire a PM? Do you want to have access to the property as a vacation home? Vacation home rentals gives you access for 2 weeks (IRS rules) plus repair time (again, talk to your accountant). The downside is that CDA has a great summer vacation rental time but the rest of the year isn't as good. PM fees on vacation rentals are also high (~25%).

Do you have time for another rehab project? The cost of 1031 is about $500 - again - talk to your accountant to see if it is worth it. When I did mine, my accountant was against it, the con is that you will eventually pay the capital gains and taxes may be higher in the future. I was pleased with the results of my 1031 because I was able to get into a more expensive project with that tax deferred money and I am older than you which means I am more likely to sell when I am old and have less income to be taxed. :-)

The CDA market (along with the rest of the USA) is strong- especially in the <$200K price range. Talk to you Realtor about inventory in your property's price range. 

So excited for you and all your possibilities! Thanks for upgrading a CDA home!

208‑762‑3367 | http://www.lisatroxel.com | ID Agent # SP39885

@Elle Scott , are you not renting the house out currently?  Rent in San Diego is high and so are home prices, but paying rent in SD and a mortgage in Idaho just for a write off isn't a very good use of your income.  You should check with your CPA, but if you had purchased a condo (or even better a 1-4 unit property) in Sam Diego, the larger payment would help your tax right offs better.  You should probably consider renting the house is you can get a positive cash flow, but if you made a substantial amount of equity with your deal, it may make sense to sell and redeploy your capital.  I'm happy to look at your actual numbers and scenario and give you my thoughts.  Feel free to reach out.

@Lisa Troxel

Great to meet you and thank you for the suggestions! In answer to your question, yes I have time for a another rehab project and the 1031, though it costs, is most likely an option Ill leverage seeing as I'm in one of the highest tax brackets right now and definitely don't need that hit on profit ;-)

 Getting into something more expensive is no problem. I would self manage if I rented it out, but I do have a feeling that selling might be the best for this one right now, especially with your tip on how the CDW rental landscape is. I'll also be doing all my own work as I have the help of experienced contractors and was raised by Buy, fix and hold parents

Agreed that checking with my accountant is vital. I would like to start off as smart as possible and utilize any advantages out there. 

Thank you so much for the advice and area knowledge, its extremely helpful! Looking forward to reporting back with great news. 

Cheers to your continued success!

Originally posted by @Shawn Couch :

@Elle Swanson, are you not renting the house out currently?  Rent in San Diego is high and so are home prices, but paying rent in SD and a mortgage in Idaho just for a write off isn't a very good use of your income.  You should check with your CPA, but if you had purchased a condo (or even better a 1-4 unit property) in Sam Diego, the larger payment would help your tax right offs better.  You should probably consider renting the house is you can get a positive cash flow, but if you made a substantial amount of equity with your deal, it may make sense to sell and redeploy your capital.  I'm happy to look at your actual numbers and scenario and give you my thoughts.  Feel free to reach out.

Oh Shawn, you are definitely seeing my issue correctly. Thank you for your post. Simply put, I was advised to have a write off prior to really truly understanding the possibilities of REI. I didn't have the best mentors then, but I do have some now and obviously BP to the rescue!

No, I am not renting it out which was fine in the beginning because I needed to remodel it and also legally couldn't rent it out as I purchased it as a "second home". I would have loved to buy a MF in San Diego but I was given perhaps not so great advice and wasn't ready without better mentoring. 

I would have had an enormous mortgage over my head which I wasn't comfortable with at the time ( again I really didn't understand REI to better leverage partners, etc)

Rental income would have raised my income, that cash flow would have been taxed heavily and I wasn't positioned to self manage at the time. 

Condo- yes that would have good but I saw the prices of Condos at the time and it was insane to me at 400k+HOA dues.

My CPA and advisors have told me that it's imperative I switch my income stream and I'm laser focused on doing so now. No more trying to dodge tax bullets while continuing to be an employee ;-) 

So with that said, redeploying my capital (given the numbers make sense to sell) sounds like a great idea to get into something bigger with greater cashflow. 

Thanks Shawn! 

@Elle Swanson

I just reread what I said about the rental market in CDA. I was talking about the vacation rental market. The long term market is great. Vacancies are low right now. I am seeing many more requests for rentals than for tenants.  You should talk to a PM about the market for your property.

 Our Spring is taking a break- after all this glorious weather that we have had lately- it is snowing this morning.

208‑762‑3367 | http://www.lisatroxel.com | ID Agent # SP39885

@Elle Scott As you alluded to, it's difficult to give you a straightforward answer to your question without fully understanding your position and goals. To me, it sounds like you are focused on building out additional streams of income and also focused on applying tax write-offs to your W2 job.

Unfortunately, these goals don't really mesh with rental real estate, at least in the beginning. Right now, I'm assuming (hoping) you are itemizing and taking the interest deduction from your "second home." Once you convert this home to a rental, you will no longer be able to take the deduction on Schedule A. You can still deduct the interest, but the immediate benefit of the deduction will be gone and your tax liability will likely increase.

You allude to the fact that you have a high income, and while rental real estate allows you to write off plenty of expenses to incur a tax loss, you likely won't be able to take those losses to reduce your W2 income. So you will have passive losses building up until you transition into real estate full-time and are able to claim the losses, or you sell the property and can take the losses. The nice thing is, if you have a solid real estate CPA, you won't be paying taxes on that rental income for a while.

In most cases, it's better to rent the place and forgo claiming the itemized deduction of mortgage interest, however without knowing your financial information, I can't say that with certainty.

Medium logo blackBrandon Hall CPA, The Real Estate CPA | http://www.therealestatecpa.com | Podcast Guest on Show #196

Originally posted by @Lisa Troxel :

@Elle Swanson

I just reread what I said about the rental market in CDA. I was talking about the vacation rental market. The long term market is great. Vacancies are low right now. I am seeing many more requests for rentals than for tenants.  You should talk to a PM about the market for your property.

 Our Spring is taking a break- after all this glorious weather that we have had lately- it is snowing this morning.

 Lol I received a picture of my snow covered propertt and then yesterday, completely clear. Oh the PNW ;) Thank you for the updated tip on rental, this has caused me to rethink my strategy. For now until I can gain a clearer picture of how a sale would effect my finances, I'm going to hold it and rent. I think the 1031 might be a good move in a year. Thanks! 

Originally posted by @Brandon Hall :

Elle Scott As you alluded to, it's difficult to give you a straightforward answer to your question without fully understanding your position and goals. To me, it sounds like you are focused on building out additional streams of income and also focused on applying tax write-offs to your W2 job.

Unfortunately, these goals don't really mesh with rental real estate, at least in the beginning. Right now, I'm assuming (hoping) you are itemizing and taking the interest deduction from your "second home." Once you convert this home to a rental, you will no longer be able to take the deduction on Schedule A. You can still deduct the interest, but the immediate benefit of the deduction will be gone and your tax liability will likely increase.

You allude to the fact that you have a high income, and while rental real estate allows you to write off plenty of expenses to incur a tax loss, you likely won't be able to take those losses to reduce your W2 income. So you will have passive losses building up until you transition into real estate full-time and are able to claim the losses, or you sell the property and can take the losses. The nice thing is, if you have a solid real estate CPA, you won't be paying taxes on that rental income for a while.

In most cases, it's better to rent the place and forgo claiming the itemized deduction of mortgage interest, however without knowing your financial information, I can't say that with certainty.

Brandon, you make many excellent points here. I definitely need a CPA solid in REI that I can sit down with and strategize best and worst scenarios. You bet Im taking interest deduction ;) that has saved me in taxes for sure.

I would be extremely interested in hearing more about the taxes on rental income. Would that simply apply to this situation or if I purchaed an additional property, say a MF, and rented it out? Thanks! 

Originally posted by @Brandon Hall :

@Elle Scott What are you interested in learning about? The tax situation changes when you purchase additional units. 

mainly about what rental income would do to my finances at this time. Frankly it will add to my bottom line and won't help offset my large income. So I'm at a bit of a standstill wondering what to do. Should I just store up capital right now, take the interest deduction from my second home and wait to have rental income? If that is taxed at my income bracket, why bother? Another proof point that I need an REI CPA lol not having rental income seems foolish to me if I have the opportunity for it.

Thanks!

@Elle Scott Your questions are great questions, just very difficult to give any sort of helpful advice because I don't know anything about your financial position. 

So let's make assumptions. 

 - Your income subject to federal tax (after 401k) is $120k/yr

 - Your second home's interest payment is $9k/yr

 - Your second home can rent for $20k/yr gross

 - Your second home has operating expenses of $9k

 - Your second home can claim depreciation and amortization of $3700/yr

 - You are single and have no dependents

 - Your itemized deductions, not including anything from your second home, are $30k

Scenario 1 - you do not rent the second home

In this scenario, your AGI will be $120k and your taxable income will be $77,050 ($120k - $30k - $9k from interest - $3,950 for exemption). This puts you in the 25% tax bracket and your total tax will be $15,119. 

Scenario 2 - you rent your second home

In this scenario, you lose the ability to itemize your interest deduction, however you are also no longer paying for the interest as your tenants are, so you can save an extra $9k per year. First we want to figure out the net income (loss) from your new rental property. The net income after operating expenses will be $11k ($20k - 9k). We then subtract the interest applicable to the loan and we are left with $2k ($11k - 9k). We then subtract depreciation/amortization and we are left with a loss of $1,700. Note, this is a paper loss. Your real income on the property was $2k, however it's sheltered by depreciation. 

Your AGI will be $120k and your taxable income will be $86,050 ($120k - 30k - 3,950). You are still in the 25% tax bracket and your total tax will be $17,369.

You may think scenario 1 is better as it results in less tax, however let's look at the real net difference. 

The tax difference is $2,250 ($17,369 - 15,119) however in scenario 2, you are no longer paying interest out of your pocket and your net income is $2k tax free. So scenario 2 gives you an "income" of $11k. Subtract the difference between scenario 1 and 2 and your real gain by choosing scenario 2 is: $8,750 ($11k - 2,250).

Obviously this is high-level, but these are the scenarios you will want to run with a CPA.

Medium logo blackBrandon Hall CPA, The Real Estate CPA | http://www.therealestatecpa.com | Podcast Guest on Show #196

@Elle Scott

It's official- the vacancy rate in the Coeur d'Alene area is now 0. My email box is flooded with requests for rentals and it isn't even May. The inventory of listings is also drying up- so sell or rent- now's the time.!

208‑762‑3367 | http://www.lisatroxel.com | ID Agent # SP39885

@Brandon Hall

 Oh my goodness, I am SO sorry. My response apparently never went through :-/ 

Thank you for this extremely thorough explanation! Its very clear with everything you detailed that I am in need of a REI strong CPA. There have been many discussions since reading your posts on whether or not to rent the second home or not. I've decided to switch some things up on my end here in SD so that I still retain the write off of the second home while I have this size of W2 income. I don't want to risk losing that in exchange for adding to the bottom line when it's really my only true write off. I'm going to instead, look into taking some of the equity out of it and purchase a cash flow property. Thank you again so very much for your help!

@Elle Scott

You said "If rental income is taxed at my income bracket, why bother?"

Your point is, being a high W2 earner, and being unable to write off any losses from real estate (as its an IRS defined passive activity),  what is the advantage? Moreover, if you had any rental income, it too would be taxed at your current marginal rate, so again, what is the advantage.

Answer : The devils in the details. One of them is depreciation. Any permanent structure on the land your rental is on, including its contents inside will reduce your rental income. If you had 10K rental profit (rents minus all expenses for interest, utilities, property tax, etc.), you would normally think that 10K will be taxed at your bracket rate. However, depreciation will further reduce this profit, so you may owe taxes only on 5K (or even zero as Brandon said). If rental profit = 10K, but depreciation is = 10K, then total income as calculated for taxes = 0K. You wont be paying any taxes even if you have 10K in real cash in your bank.

Free eBook from BiggerPockets!

Ultimate Beginner's Guide Book Cover

Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!

  • Actionable advice for getting started,
  • Discover the 10 Most Lucrative Real Estate Niches,
  • Learn how to get started with or without money,
  • Explore Real-Life Strategies for Building Wealth,
  • And a LOT more.

Lock We hate spam just as much as you