Negative (Fully Loaded) Cash Flow BRRRR or Flip?

10 Replies

Hi -

Newbie question. A favor, please. If you are using #s to explain something, please pull from the #s below.

I am in the process of buying my first long-distance property. First the #s:

$150k purchase price

$50k repairs

$260k ARV (I hope)

$1750/mo - would be rent

W2 employed.

Selected the market because it should appreciate

Property tax - ~3% of appraised value ($150k*.03/12mo = $375/mo). 

Paying Cash

Ok, here goes.

I am buying the above, and it would not cash flow if one considers things like CapEx, Repairs, Vacancy, etc. If you ignore those, it would break even. The problem is most likely the local taxes for investors in South Carolina. My current thinking, and I waffle, tells me to flip, take the $45k post-sale profit, and do a 1031 Exchange. This then could become two properties and somehow I could use this profit for the next two.

Or, if I could get a realtor as good in Tennessee or similar, flip in SC, hold in this other market. My realtor is a true rock star, and I have not found another like her, and question where they exist that is not super-saturated with investors.

1. Does a 1031 hurt resale price (ARV)? Do potential buyers see it as a negative?

2. Everything I see about 1031s talks about two factors - sale price and loan amount. I won't have a loan, so how does that work? 

3. I want to BRRRR, not flip. Is it better to BRRRR it and just deal with those expenses? Or keep a bunch of capital locked up? The problem, like I said, is the tax issue, so, $10k left in the property is about $25/mo savings in positive cash flow. So, I'd have to leave not just my forced appreciation locked up, but also another big chunk of capital to get to a fully-loaded cash flow.

4. Does this high investor property tax really help me with my personal taxes? To explain that a bit - BP talks a ton about cash flow (monthly), but I do not see cash flow annualized on BP, but in this case, this tax could be not-so-bad? 

Really, my question is, 'what would you do?' I will talk to my local accountant tomorrow, and my long-distance accountant on Saturday, but want all the data I can get.

Any advice welcome. 

Thanks for your time!

Erik

I think I would do a 1031. The buyers have no idea that this is what your doing and probably wouldn't care if they did know so this will not affect the sale price.

You have timelines for a 1031 You have to identify a property within a time frame and close within a time frame. None of this affects sale price or loans (if applicable). You need to have a certified 1031 exchange company receive the money and hold it. Then you have to buy something of equal or greater value.

You could do the 1031, buy the new property/s and then still do a cash out refi if you wanted to.

The 1031 will allow you to postpone capital gains taxes, maybe indefinitely if you keep doing this or hold the property you buy and pass it on to your heirs.

Hi @John Underwood -

Thanks for your time. It is the opposite of what my accountant said. She says that flips are NOT "held for productive use in the trade or business". She strongly recommended that I hold the property, even at a fully-loaded loss, because the tax savings more than offset paying those short term capital gains. 

I will talk to a tax-planning expert in South Carolina in the next day or so, to get a second opinion. 

Any additional thoughts very much appreciated.

Originally posted by @Erik Perotti :

Hi @John Underwood-

Thanks for your time. It is the opposite of what my accountant said. She says that flips are NOT "held for productive use in the trade or business". She strongly recommended that I hold the property, even at a fully-loaded loss, because the tax savings more than offset paying those short term capital gains. 

I will talk to a tax-planning expert in South Carolina in the next day or so, to get a second opinion. 

Any additional thoughts very much appreciated.

 I missed the part where this was for an intended flip.

If you are going to flip houses I have always heard to do these inside an S corporation.

I have flipped a couple inside my ROTH IRA and pay no tax on these.

@Erik Perotti timelines are important with 1031 exchanges and I don’t believe you can do a 1031 unless you have owned the property for over a year. @Dave Foster would know better than me when it comes to 1031 exchanges. 

Just looking at the deal, however, I defiantly would not encourage you to buy anything negatively cash flowing right now. That is how the investors who lost in 2008 and 2009 did it. The bought negative cash flowing properties hoping for appreciation and then the market crashed and they were left with properties that negatively cash flowed that became worth less than they paid for them. So no I would not encourage you to buy something now that is negatively Cash flowing. Also, your likely profit on the deal would be more like 30k minus short term capital gains with those numbers above if you used all of your own money on the deal.

Thank you @Shiloh Lundahl - I second your opinion, I have now spoken with two folks (the second this morning (a tax planning attorney in South Carolina)), and they are both strongly advising that flips should not be 1031 Exchanged. The reason is that the Government does not want them daisy-chained together to avoid taxes. Flip 6 successive houses and just hold the last $18m place for a year or two.

The 1 year/2 year question is interesting. In my opinion (and I am no expert, to be sure. Read at own peril, not offering advice etc etc) It's all about intent. As I now understand - if you intend to hold the property for two years, and your circumstances change and you decide to flip it after the first year, that would permissible. 

The cash flow question is more nuanced, in my uneducated perspective. If you listen to BP podcasts, some folks talk about cash flow as just the mortgage and so forth (especially if the house is spruced up with new infrastructure), while the more conservative investors consider cash flow to consider the other factors of CapEx, vacancy, etc. The advice I am hearing from these tax folks is the lost cash flow is more than made up for with moving away from short term capital gains.

Not sure yet, definitely two sides to the argument. Regardless - I very much appreciate your insight!

By the way, I listened to your episode on the BP podcast a month or so ago, and learned a ton! Thanks for sharing your wisdom.

Erik

@Erik Perotti , It comes down to intent. If your intent is primarily to resell (fix n flip) then the 1031 is not appropriate. If your intent is primarily to "Hold for productive use" then the 1031 would be appropriate. So if you're buying this house to flip then no 1031. If you're buying it to hold and BRRR then that would qualify for 1031. A perfect example of an intent that has changed is exactly what your accountant is telling you. If you bought that property to hold and now it's turned into the money pit holding on to it just to avoid short term tax is foolish! Your intent was not to sell but you made a mistake and now need to sell. That's one of the things that can demonstrate your intent. Beware though. An accident like this where we screw up and have to sell a property we wanted to hold can happen to anyone and become a very legitimate 1031 opportunity. When that same "accident" happens 5-6 times a year it's probably something less accidental isn't it.

If you bought this as a flip no 1031. If you bought this as a BRRR and need to sell. Then sell and 1031. Don't hold it at a loss - that's crazy talk.

Other answers:

Your 1031 has no bearing on ARV or desireability to a buyer at all.

If you want to defer all tax you need to purchase at least as much as your net sales price and use all of the cash proceeds in the next purchase or purchases.  If you have no debt then the net sales price and cash proceeds are the same amount.  So you must purchase at least as much as you sell if you want to defer all tax.

Thank you @Dave Foster . I have no intention of holding at a loss. Its a matter of accounting (or not) for CapEx and/or Vacancy. From where this sits, this is a first world problem. There is money to be had, the question is how to best maximize that return in the long term.

@? Love first world problems!!  And your follow up statement sounds more like someone wanting and planning to hold but who may not be able to.  Memorialize similar conversations with all of your professionals.  They all go to paint a picture of an intent to hold which will back up your decision to 1031.

 If you decide to 1031 then the bulk of your expenditures to put the property into service  will be capitalized.  They'll impact the basis of this property and subsequent basis of the new property.  If you treat as a flip then they'll all affect p/l and act as ordinary expense. This is where your accountant can help you determine the impact on a tax return.