So I jumped on the band wagon and bought a fixer upper..........
Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes
So I jumped on the band wagon and bought a fixer upper..........
Most Popular Reply
Two things are painfully obvious after reading your post:
1. You didn’t have a clear exit strategy in mind before you made this purchase
2. You could have used a little more research time to better understand all of the implications of what you were getting yourself into.
It’s not clear to me from reading your post what your objective was when you made this purchase as you rented it for three years, but are not happy with the tax benefits or lack thereof. And you’re not happy with the capital gains taxes after selling.
The saying goes “you make your money when you buy a property” and it sounds like you dove in head first without a solid understanding of that point only to experience an outcome that was not what you expected.
The great news is that the experience you gained here has the potential to be invaluable, and totally reshape your approach to investing. There are a lot of people making a lot of money from real estate and the difference between you and them is the time they’ve invested into learning and perfecting their processes. Only you know how much time you spent doing the above, but if you aren’t getting the results you desire, the answer isn’t to do (whatever you intended to do above NO DISRESPECT), but to learn from your mistakes and avoid making the same ones next time. Good luck on your journey, and don’t let this one setback deter you.
“The champ will always be the champ so long as (s)he continues to get up!”
53 Replies
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
Lolol, thank you Anna. Im one of those people who wont stop till I get something right, and that alone is why I CAN'T quit now. I have too much to make right, lolol.
- Houston, TX · Member since 2019 · 23 posts · 23 votes7y
@Angelique A.
I’m grateful to you for sharing your experience and the replies it generated. There is gold in this thread, so rest easier knowing that your hard times will help others like me when we start investing.
Thanks to everyone that contributed.
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Mark Rocka
Best of luck in finding the right people to guide and help you get it right so you know what to expect and you don't lose your hard earned money.
- Member since 2019 · 226 posts · 115 votes7y
@Angelique F. Unfortunately great tax planners are expensive, so you have to make sure it is truly worth it before you go down that rabbit hole. If your entire profit is 8K, there is no reason to spend 5K on tax advisors when you can just pay $3K in taxes and move on.
If you are tagged as a dealer on this house, the 10K would be treated like inventory and anything you do to it should be tax deductible. For example if you pay 10K for the house, spend 40K to fix it up and got 60K in a sale after all fees. Your ordinary income (taxed at whatever bracket you are at) is 10K. There is no capital gain. Flippers don't qualify for capital gains. If you get lucky and don't get tagged as dealer, yes you would have to go through and depreciate a lot of the expenses. Every year you will only be able to get a small portion of it to offset your rent income. When you sell it, you pay the gain on the house subject to recapture, not on the sales amount. For simplicity sake, let's say you paid 10K, did 40K of capital improvement, took 5K in depreciation every year. When you sell it for 60K in year 2, you would actually pay capital gains on 10K (should be lower than your current tax rate, it is below 20%) because your house is worth roughly 40K, but you add the depreciation back in to get back to 50K as your basis.
Remember GAAP, tax and cash accounting are all different. Sorry...
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Tom Makinen
Tagged as a dealer? Whew, I'll keep reading and disecting your post trying to understand what you are telling me, cuz omg, this stuff is very difficult to understand. Thank you.
- Member since 2019 · 9 posts · 6 votes7y
"I shouldn't say I wont do it again. I will use Roofstock (I think) next time. I still got some research to do on them, but so far I like what Im reading. When I sell my primary residence, I will not buy again, I will rent, and I will buy a couple of investment properties buy and hold. I think, lol.
THIS IS THE BEST PART in the whole thread. You're pissed, but not quitting. You did learn a ton and will do so much better next time!! Go you!! Love hearing that you got screwed and are ready for round 2!! Yes, we do need more of these stories, bc if I had to guess, in 10 years, you'll be a real estate GENIUS!!! "
I, too, was thinking someday @Angelique F. might end up being a RE Rockstar. Thank you, Angelique, for sharing your experience.
- Member since 2019 · 226 posts · 115 votes7y
@Angelique F. when you flip you are consider a dealer, that just means you get to expense everything. The repairs you made offset your sales.
If you report the property as an investment, you depreciate and get better tax treatment.
Flip=business
Rental=investment
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Mary H.
Thanks Ladies. I wish I could quit my job and do this full time. Thatl learn me, lol.
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Tom Makinen
Oh. Well how soon after acquisition, then sale would make you a dealer? I had the home almost 5 years. That what have to be the slowest flip on record, LOL
- Rental Property Investor · TN · Member since 2018 · 2k+ posts · 2k+ votes7y
@Angelique F. if you go back into the fix and rent mode in the future, this information might help you accept the improvements being taken out as depreciation on your taxes instead of immediately as deductions. And, yes, some tax folks like to take out all costs prior to the first rental for major disaster fixer uppers as depreciation (like its part of the initial cost of the property).
When you start out you will have a lot of start up types of expenses, minor repairs that can be take off as deductions and major ones that can be only depreciated. Often you will have so much in deductions that it completely offsets your rental income. But as time goes by and you have fixed up the house and it is rented, say 3 to 15 years after it was fixed up, you will only have very minor expenses compared to the rental income. That is when you would really appreciate that you have the improvement depreciation over 27.5 years (or whatever) for your taxes.
Most people do not keep their rentals long enough to appreciate this period of rental life.
I do buy foreclosures, houses that are a mess and fix them up. I just consider all the fixing up prior to the first rental as if it is part of the purchase price. And it will be deducted over time...I do not expect these cost to be immediately deducted.
- Member since 2019 · 226 posts · 115 votes7y
@Angelique F. Per the IRS, it is the intend. It seems like your accountant already treated it like an investment property as you took depreciation instead of expensing everything. Since you didn't hear back from the IRS, I am guessing they didn't give you dealer status for this house. Remember IRS is not 100% cash basis on real estates. Also less deduction you take now, less you pay when you get the depreciation recapture. Accounting doesn't lie...
Example 1, dealer status
Year 1 Purchase Price 10K
Year 1 Reno 35K
Year 1 Sold Price 50K
Year 1 Taxable Income 5K as ordinary income (let's call that 25%)
Example 2, investment property
Year 1 Purchase Price 10K
Year 1 Reno 35K
Year 1-5 Rent Income 3K/year
Year 1-5 Depreciation 1636/year
Year 1-5 Taxable Income basis of 1364 as passive income (your tax rate, call it 25%) (This is for the rental income)
Year 5 Sold Unit 50K
Year 5 Additional tax event for capital gains as you made money on it. Since your house is only worth (45000-8180=36820). You would be subject to add back in the $8180 as depreciation recapture to get you back to 45K where your cost basis was. At the end of the day, you would pay capital gains on $5000 (<20% in tax rate) and $8180 at your tax rate (25%).
Before you complain, look at that math above. You are essentially paying the same except depreciation allows you to keep more cash up front. All the taxes you are paying at Year 1-5 is for your rental income, not the actual house. I know it sucks as you put down 45K up front to do the project, but it makes no difference from an accounting perspective.
In 5 years, you would pay 25% of the following amount (1364+1364+1364+1364+1364+8180) + capital gains (<20%) of 5K.
Why is it good to avoid dealer status for flips. Look at the example above. If you got labeled a dealer and IRS won't let you depreciate the property.
Y1 - Buy property + reno 10+35
Y1-Y5 Rental income 3k per year
Y1-Y5 Passive income tax on the 3K @ 25%
Y-5 You sell the property and got a gain of $5K. Since you got tagged as a dealer, you have to pay ordinary income at 25% for the 5K. In the 5 years, you would pay 25% of (3+3+3+3+3+5=20K)
Not having the dealer status allows you to pay less taxes on year 1-5 and then less on the 5K in capital gains you received since it is taxed at a smaller percentage than your tax bracket.
Originally posted by @Tom Makinen:
@Angelique F. Per the IRS, it is the intend. It seems like your accountant already treated it like an investment property as you took depreciation instead of expensing everything. Since you didn't hear back from the IRS, I am guessing they didn't give you dealer status for this house. Remember IRS is not 100% cash basis on real estates. Also less deduction you take now, less you pay when you get the depreciation recapture. Accounting doesn't lie...
Example 1, dealer status
Year 1 Purchase Price 10K
Year 1 Reno 35K
Year 1 Sold Price 50K
Year 1 Taxable Income 5K as ordinary income (let's call that 25%)
Example 2, investment property
Year 1 Purchase Price 10K
Year 1 Reno 35K
Year 1-5 Rent Income 3K/year
Year 1-5 Depreciation 1636/year
Year 1-5 Taxable Income basis of 1364 as passive income (your tax rate, call it 25%) (This is for the rental income)
Year 5 Sold Unit 50K
Year 5 Additional tax event for capital gains as you made money on it. Since your house is only worth (45000-8180=36820). You would be subject to add back in the $8180 as depreciation recapture to get you back to 45K where your cost basis was. At the end of the day, you would pay capital gains on $5000 (<20% in tax rate) and $8180 at your tax rate (25%).
Before you complain, look at that math above. You are essentially paying the same except depreciation allows you to keep more cash up front. All the taxes you are paying at Year 1-5 is for your rental income, not the actual house. I know it sucks as you put down 45K up front to do the project, but it makes no difference from an accounting perspective.
In 5 years, you would pay 25% of the following amount (1364+1364+1364+1364+1364+8180) + capital gains (<20%) of 5K.
Why is it good to avoid dealer status for flips. Look at the example above. If you got labeled a dealer and IRS won't let you depreciate the property.
Y1 - Buy property + reno 10+35
Y1-Y5 Rental income 3k per year
Y1-Y5 Passive income tax on the 3K @ 25%
Y-5 You sell the property and got a gain of $5K. Since you got tagged as a dealer, you have to pay ordinary income at 25% for the 5K. In the 5 years, you would pay 25% of (3+3+3+3+3+5=20K)
Not having the dealer status allows you to pay less taxes on year 1-5 and then less on the 5K in capital gains you received since it is taxed at a smaller percentage than your tax bracket.
This post is incredible, thank you! Super helpful to see nitty gritty info like this on a complicated subject.
I'm going to have to add my voice to the chorus saying "THANK YOU" for this thread, Angelique. This is the kind of thing we really need. And I love your attitude. A lot of people get hit hard, and they walk back to their corner and say, "No more, I'm buying mutual funds." Yet here you are, snarling and ready for the rematch. And you should be. YOU PAID YOUR DUES.
I'd like to go over some of the main points I think you're making and illustrating here.
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NUMBER ONE: There's no point in heavy-duty rehab unless you have an equalizer on your side. Otherwise, you're just making contractors rich. It blows my mind that so many people who get into this think that somehow, they're going to make money on rehab by managing contractors they just met yesterday. That fixing a house is just a matter of properly handling guys who are selling their work for well under what it's worth. Why? Because they're stupid blue-collar people who can be led around a big white-collar brain. That's just not how it's going to work. Unless you have an in, you're not going to get anywhere.
NUMBER TWO: Get an accountant who knows real estate. We started with "a tax lady," just like you. Ain't gonna cut it, ever. You need a CPA who handles filing for real estate. S/he is going to be expensive as hell, and worth every penny.
NUMBER THREE: Get the Bigger Pockets community on your side. You joined this community in 2013. You've posted 62 times in those six years. The stuff that's hitting you now sounds like calculus. No, that's not going to work. Anyone needs hard time on this website to figure who knows what they're talking about when they post, when they're spouting hot air, and when they know exactly what they're talking about.
NUMBER FOUR: Read, listen, ask. Before you set up legal entities, read up on them. Before you go into a major repair, figure out how it's done. Before you crawl into bed with anyone for any reason, find out about that person. Make it a point to read 20, 30 books a year about this business. The BP community is a great place to ask further questions about what you've read. Trust with difficulty, verify as a matter of course. Assume the worst first before you start hoping for the best. I love Shaquille O'Neal's story. Everyone assumes they're just going to manipulate the big man in business. So he calmly goes off and gets MBA and now they have to talk to him across the table, not his business managers. Everyone assumes he's just going to hand over his money for good educational causes. So he goes off and gets his doctorate in education, oopsies, shuts that down. Now he's in law school so that the lawyers can't give him a runaround. They decide to put him in films as a public figure? Off he goes to film school. You can't get around Shaquille with the shop talk.
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The next time you have a rehab question on an SFR, I'm just going to assume right now you're going to ask me in the DIY forum, OK, Angelique? I wish BP had a Rehab Management forum where people could ask questions about what they're contractor is telling them absolutely HAD to be done, maybe someday we will. Good luck to you going forward!
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Jim K.
You guys and gals are amazingly generous with your time and knowledge. I'm going to print your postings and crawl under the staircase and study them:). This information is invaluable, but it's really difficult to understand. I mean the terms and math alone are enough to scare people away. For that reason alone you're gonna get people like me who just jump in and hope for the best, and they will have regrets, they will lose money, but at least they will learn what NOT to do.
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Tom Makinen
You're friggen amazing Tom.
@Angelique F. sorry you are frustrated but as others have said its not all doom and gloom as your accountant may have told you. It sounds like maybe you just now sold the property and are anticipating what your taxes will be for this year when you file next, if that is the case it's not too late to change accountants. If somehow I've misread that part then I apologize, either way I am local to you and have a good CPA for your taxes, not far away from you in Algonquin, and he is also an REI investor so he gets all the ins/outs of real estate and taxes.
Feel free to DM me if you need more information or even to meet up and talk over a cup of coffee since we are not far away from each other if you'd like.
Mark
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Mark Faustrum
Mark I would truly appreciate your referral. Finding accountants and attorneys who understand rei have not been my strong suit. Even after specifically seeking them out, sitting down and discussing with them in detail the need for creativity as it relates to the tax laws which we all know are not black and white. I will dm you and thank you very much.
- Flipper/Rehabber · Member since 2019 · 61 posts · 22 votes7y
@Angelique A.
Why did you sell it ?
Why not keep it
aka (( buy @ hold ))
over time ...of course this is NOT a instant world
Will re-coop your investment then after you back even ...then the rent returns to your pocket
- Flipper/Rehabber · Member since 2019 · 61 posts · 22 votes7y
@Angelique A.
See yes you are leaning
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Richard Ring
I just don't want to manage a property so far from my home anymore. When the tenants lease ended last September, I told them I would NOT be renewing it. For three long years they refused to pay on time. I put up with that shyt for waaaay to long and had I depended on their payment to pay a mortgage, I would have lost the damn house, so I'm just glad to be done with them and the property.
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
@Angelique A
However, if I had known I needed a QI for the exchange, I certainly would have gone that route. I asked my accountant about a like kind exchange and she said oh, that's not allowed anymore. Omg just shoot me.
- 7yDave FosterBusiness MemberQualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
@Angelique F. The information has kind of dribbled in but I see nothing in your latter posts to indicate any unfavorable tax situation other than that ridiculous claim by your accountant that 1031 wasn’t available.
You owned it for multiple years and demonstrated your intent to hold.
Your accountant evidently treated it the same and gave you the depreciation benefit.
It sure sounds to me that you’re going to only pay capital gains rate and have to recapture the depreciation.
Only way that gets better is if you did the 1031(which is alive and well for real estate). Then you could have deferred all tax and depreciation recap.
I’m sure the process felt like root canal without anasthesia but you may not be as bad off as you think.
The 1031 Investor5137 Reviews - Flipper/Rehabber · Member since 2019 · 61 posts · 22 votes7y
Property Managers generally only charge 10% of the rent that way you are NOT involved with the tentants at all
iE : if the rent is 500 per month a Pm fee would be 50 with NO headaches
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
Dave, what I felt was unfavorable and the reason for my rant was the fact that I was misinformed, uninformed and misguided. Yeah, I came out of it (ok) in that I did make a profit thank Gawd, but to me the process was not fun and had it not been for my determination and will to fight through the BS, things could have gone even further left. Thas all Im sayin.
- Rental Property Investor · Atlanta GA · Member since 2013 · 122 posts · 83 votes7y
Trust me Richard Ring, I interviewed the property managers in that part of town and they were shady as all hell.
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