Buy property from parents and renovate it?

Question

Good morning,

I want to bounce some ideas off you guys and perhaps get some feedback. Here’s the situation:

My father owns a 2 Bds/2 Baths house (1190 sq ft) in Pasadena, CA. Nice little house in a nice neighborhood and approximately 25 min from downtown LA. It needs some upgrades and repairs before we rent it out or use it as an AirBnB. So my plan is to sell a different house I already own in WA. I want to use the money from that sale to pay for the renovation or as a down payment for my father’s house in Pasadena (if I decide the purchase the house). My dad and I had a few ideas on how to go about our plan.

Path 1:

I buy the house from my dad and use the money from the sale of my house in WA as a down payment. He gives me money for the renovation. We renovate it and rent it out or use it as an Airbnb. One of the reasons my dad prefers this path is because he only stays in this house once a year for a month or two. He lives overseas with my mom and doesn’t want to take care of it or worry about it.

Path 2:

My dad keeps the house under his name and I use my money from the sale of my house to renovate it. Once complete, we rent it out or use it as an Airbnb.

Questions/concerns:

What are some pros and cons with buying a house from my dad?

Rent vs Airbnb

I’d prefer renting the property out but with Airbnb we have the option to still use it when my parents are back in the US or I’m in town.

Background:

my dad/mom live overseas and stay in the house once a year for 2-3 months only. Once renovated and rented out they will stay with family when visiting the US.

I currently live in AZ (military) and stay in the house for a week or two once a year.

The house as it is, is approximately worth $850,000.00.

I’ll make about $100,000 profit from the sale of my house in WA.

Brad S. · Answer

@Dennis Guinto

Individual decisions should be based on the end goal/s. Are you looking to build cashflow, to have a place to move to later, etc.

With that said, here are some considerations:

1) Transferring title (you buying the house) will trigger a reassessment (higher property taxes), which will significantly affect any potential cashflow. The parent to child transfer of property tax base, was changed this year, due to Prop 19. Your situation does not seem to qualify for the tax base tfr. In order to qualify now, the property has to be your parents principal residence, and the property must become your principal residence within one year of the tfr.

The real world difference for you, is around $270/mth in additional property taxes. Right now, they are around $6,500/yr or $545/mth, that will go up to around $815/mth for a new assessed value of $850k

Also, don't make the mistake of thinking you can circumvent that, by having your Dad sell you the house at a discount, and therefore, think you will get a lower assessed value. While it might influence it somewhat, the assessed value should based on "value" not sale price. Therefore, an under market sale, may be assessed significantly higher than the sale price. Notice I am saying "should" and "may" since nothing is set in stone, but I wouldn't rely on the lower potential assessed value.

FYI - this is based on my past professional experience as an ex-Deputy Assessor for LA County. I was one of those people that used to assign some of the assessed values to tfr's, so I have some experience.

2) Market rents for similar properties in that neighborhood, are between $2850-$3,600, with the $3,600 being a "gorgeously updated craftsman," on a larger lot than yours. It also has a bonus room with the potential of a home office or 3rd bedroom. And 2 of the other higher rents are for 3 bedrooms homes ($3,350-$3,375).

Therefore, I wouldn't count on the higher range of rent for yours. The 2 bed/1 bath houses have rented in the range of $2,600-$2,900/mth, and they look like they are in average condition with average quality. So, renovated and having a 2nd bathroom, may help you get more rent. Also, they seem to be renting fast between 3-11 days on market, with one being 62 days (out of 7 total rentals).

3) So with those previous #'s, there would be a negative cashflow

SP - $850k

Down pmt - $100k

Loan- $750k

Pmt @ 3% = $3,162/mth

taxes = $815/mth (with new assessment)

insurance = $150/mth (guestimate)

PITI - $4,127/mth

Of course, those #'s are for a conventional purchase and new loan @ market rates. Those #'s can change drastically, if your Dad is carrying the paper (loan) and giving you favorable terms, or not charging interest, etc.

4) There is an option of converting the garage into an ADU, or adding an ADU over or adjacent to the garage. A 1 bed/1 bath 500sf guest house, in the neighborhood, recently rented for $1,700/mth after only 4 days on market.

So, let's say you can add/convert to an ADU for around $150k, that translates to around $630/mth additional loan pmt ($150k @ 3%), which would net you around $1,070 ($1,700-$630) in rent from the ADU, not taking into account additional property tax assessment or insurance.

Actually, I just noticed that previous $3,600/mth craftsman rental is the same property as the guest house ($1,700/mth) rental. So, all in all, it is very similar to what yours would be with an ADU, and that one is getting a total of $5,300/mth for both units (keep in mind that house's 3rd bedroom or office potential).

Looking at Pasadena's STR rules, it appears the property has to be a "primary residence" of the host, defined as where they reside at least 9 months per year. Seems to exclude your situation.

Also, be careful, if you are considering having your Dad transfer the property to you now, since that will affect the tax base value later, if you liquidate it and have to pay on the gain. That's referring to income tax rules, not property taxes. Talk to a CPA, if you are considering that.

Also, there are the new Senate Bills, SB9 and SB10, which are aimed at increasing density on R1 zoned lots. I am not going into those, since I haven't fully reviewed them yet, but those might provide more options to your situation.

That's some info and #'s for you to chew on. Do your own calculations, etc, and you can get a clearer picture of what might work for your situation. And as always, don't make any major decisions based on advice from this site (or anywhere else online), at face value, without consulting specific professionals regarding your specific situation, etc. (i.e. CPA's, attorney's, Brokers, etc.). P.S. my analysis was based on what I believe to be the actual property, which I was able to find, based on the little info in your original post.

Jimmy Woodard · Answer

@Dennis Guinto based on the situation, it doesn’t look like you’ll qualify for an Airbnb in Pasadena. Un-hosted stays are limited to 90 days maximum per year and the owner has to reside in the property at least 9 months out of the year.

Dan H. · Answer

@Brad Sand did a good job indicating how prop 19 is screwing you if your dad sells to you. He also outlined the risks associated with trying to circumvent the prop.

What he did not address was the gains tax if your dad sells to you. Assuming he does not do anything like a 1031, he will be taxed on gains (assuming he has not lived there 2 of the last 5 years).

Under current rules (assuming you dad’s estate is not over something like $12m), if your dad holds the property to death and you inherit the property, there is a step up gain and no one pays taxes on those gains.

So I see two big reasons to keep property in your dad’s name 1) prop 19 and the resulting step up in property taxes 2) it would trigger a gains tax that currently vanishes if you dad keeps the property to death (maybe with you helping to manage it).

I suspect both @Brad Sand (it matches what I believe) and I gave you correct info, but you should always verify such info with a trusted, knowledgeable source (financial planner, cpa, etc.)

good luck

Gina Tse-Louie · Answer

Be careful of how Proposition 19 will affect you as a rental.

Help us to #FiXProp19 by #RepealTheDeathTax. Download, print, wet ink sign and submit. Signer can be Circulator (witness for self and others). Complete BOTH sections. We need 1.3 million signatures to get on November 2024 ballot. Volunteer and Download petition at ForCalifornians.com or RepealTheDeathTax.com.

Dave Foster · Answer

@Dennis Guinto, one other factor if you are wanting to sell your other property and do a 1031 to buy your father's property is that would be a related party transaction. And while is is generally possible to sell to a related party in a 1031, buying from a related party is very very difficult to prevent a charge of basis shifting from the IRS.

If you want to do this as efficiently cost wise and conservatively tax wise you may want to consider a refinance of a property to fix your fathers property keeping him on deed. Have a management agreement that provides you the opportunity to manage and profit until your fathers passing when you'll get the step up in basis.

Jerome Caldito · Answer

@Dennis GuintoWhat area of Pasadena is the property located? If you're in the unincorporated portion of Pasadena, you may subject to the LA County Airbnb rules vs the previously stated Airbnb rules for the City of Pasadena.

Here's a quick map I found. If you're outside the blue area, but still have a Pasaena address, you'll fall under the Unincorporated LA County rules:

City Map

Dennis Guinto · Answer

Thanks for the response! The AirBnB plan was just and idea and we are not stuck on it. My dad and I prefer renting it out long term after we renovate the property. Next step would be finding a lender and figure out which loan type.

Charles Renn · Answer

Hi @Dennis Guinto, @Jimmy Woodard hit the nail on the head. AirBnB has restrictions in Pasadena and I'd recommend reading up on it yourself as well, but this is a hurdle worth exploring. I know your family like to stay in the house at times throughout the year, but since you both have homes to live in outside of Pasadena, would you consider renting this home long term? Depending on the exact location 2br homes in Pasadena are a hot commodity in the rental market. I imagine the cash flow after a remodel from the consistent rental income would be a great way to build wealth.

Hope this helps!

Buy property from parents and renovate it?

Buy property from parents and renovate it?

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