I recently purchased a house in Burbank, California.  It was a long process finding a house that made investment sense in a location with such high demand and such high prices (average cost is $750k for a 1400-1500 square foot 3 bed 2 bath older home).  What attracted my wife and I to purchasing this particular house is that it has a huge high-pitched roof and a guest house in the back. 

The house is currently a 2 bedroom 2 bathroom 1400 square foot house that we are going to add around 800 square feet to by adding 2 bedrooms and another bath/laundry room and 2 lofts up in the enormous attic, thus making it a 4 bedroom 3 bathroom 2200 square foot home.  We are planning on making this a live in flip and then selling it in the next 2-3 years after we complete the addition for around $180k.

The raise I gave myself has to do with the guest house in the back.  The guest house is a 400 square foot finished house with a kitchenette and a 3/4 bathroom.

Because of the high demand for housing in the area, we were able to charge $1500 a month for the guest house (that included utilities, internet, and laundry access in the garage).

The tenant is reducing my mortgage payment by $1500 a month thus lowing my yearly expenses by $18,000 a year.  In order for me to net $18,000 more a year I would have to earn around $24,000 more a year if I were to pay around 25% or $6,000 more a year in income taxes.

Now, I know this example doesn't take in to consideration the increased utilities that the tenant uses, and it doesn't take into consideration taxes that I may need to pay on the $1500 a month (which I will be working out with my CPA to figure how to minimize that).  But, nevertheless, the decreased monthly expenses was equivalent to giving myself a tens of thousands of dollars raise each year through this version of a house hack.

Originally posted by @Shiloh Lundahl :

I recently purchased a house in Burbank, California.  It was a long process finding a house that made investment sense in a location with such high demand and such high prices (average cost is $750k for a 1400-1500 square foot 3 bed 2 bath older home).  What attracted my wife and I to purchasing this particular house is that it has a huge high-pitched roof and a guest house in the back. 

The house is currently a 2 bedroom 2 bathroom 1400 square foot house that we are going to add around 800 square feet to by adding 2 bedrooms and another bath/laundry room and 2 lofts up in the enormous attic, thus making it a 4 bedroom 3 bathroom 2200 square foot home.  We are planning on making this a live in flip and then selling it in the next 2-3 years after we complete the addition for around $180k.

The raise I gave myself has to do with the guest house in the back.  The guest house is a 400 square foot finished house with a kitchenette and a 3/4 bathroom.

Because of the high demand for housing in the area, we were able to charge $1500 a month for the guest house (that included utilities, internet, and laundry access in the garage).

The tenant is reducing my mortgage payment by $1500 a month thus lowing my yearly expenses by $18,000 a year.  In order for me to net $18,000 more a year I would have to earn around $24,000 more a year if I were to pay around 25% or $6,000 more a year in income taxes.

Now, I know this example doesn't take in to consideration the increased utilities that the tenant uses, and it doesn't take into consideration taxes that I may need to pay on the $1500 a month (which I will be working out with my CPA to figure how to minimize that).  But, nevertheless, the decreased monthly expenses was equivalent to giving myself a tens of thousands of dollars raise each year through this version of a house hack.

 Wow that's fantastic, congratulations.

I read your profile it looks very comprehensive, in the sense, you have experience doing many different types of deals (buy/hold, fix/flip, buy/lease, etc.).  Maybe you can teach us all something by discussing a little bit about why you do the deals you do in each arena, and the pro's and con's :)   My thought is that if one is better than any of the others than why not just stick to that ..? Curiosity killed the cat 

Thank you.

Awesome job! Not to burst your bubble a little bit, but you will have to pay taxes on the rental income, and more likely at a higher rate than your normal income. You will have expenses to offset it some but it is not tax free money, as you may have thought based on your post.

@Samir Shahani I guess I would look at it though this analogy, when you are looking for dollars on the ground, don't pass up the quarters.  

I would say that we get our biggest profits from our flips, but they seem to be getting harder to come by.  I could just wait for more opportunities to arise for flipping, or I could learn other aspects of real estate while I am waiting to come across more flips.

This year we decided that we wanted to get some buy and hold properties, but we didn't want to have regular rentals with the associated stresses that can come with being a land lord.  So rather than doing straight rentals, we decided to do lease options.  This way we could take out the 3 biggest expenses of having rental properties (vacancy, turn over, and capital expenditures) and we could cash out in 5 years.  So far we have purchased 11 properties to lease option this year and we have 7 already optioned with another one signing next week and the other 3 just came up on the market.

The general rule of thumb for us is if we are able to get the house and rehab done for less than $150k then we will try to do the lease option.  If our total in is more than that then we will probably do a flip.  When we run the numbers, we want to make at least $20k profit on each flip.

@Jason D. I figured that we would probably have to pay taxes on rent received, but I am going to talk with my CPA to see if he is able to work any of his accounting magic around this.  It does still offsets a lot of our home expenses though.

@Jason D. I talked with my accountant, and unfortunately, I will need to pay rental income on $1500 which is a bummer.  He did say that I would be able to deduct all of the costs associated with the property though.

good work... solid investment  keep it up.

Thanks @Jay Hinrichs .  A complement from you means a lot to me.  

I am a big believer in taking care of buying a roof over your head when you live on the west coast and if your going to live there for many years.. history over my 40 years on the west coast has proven this to be an excellent investment

Not to mention when you sell after 2 years all gain is TAX FREE other than figuring out the rental part.

So, I feel I am absolutely the LEAST qualified to give advice here, but I've been reading like a madman, and what you did sounds exactly like what Ben Leybovich does in his book House Hacking (here on BP).  He has it spelled out exactly how he deducted a specific percentage of the utilities based on the size of the house rental. Or something like that. Hard to evaluate information without framework on the topic.  Anyway, I can highly recommend that book! Looks like you are already DOING what it is trying to convince you to do.  Maybe he will have some golden ideas in there to make your tax season more friendly at least! I'm quite jealous on how well you have made this work.  Really hoping to do the same myself! 

@Adam Britt it's funny  that you would mention @Ben Leybovich . He is in Arizona now and he and I went out to lunch and talked about his book and about what I was planning on doing with my guest house in Burbank, California.

Congratulations! That's awesome. I'm assuming you have a long-term renter in the back but have you ever looked at what you could get with a short-term renter (ie. Airbnb, etc.)?

@Shiloh Lundahl

Well, what a small world! I bet you already got the goody then! Man, I sure would love to find more investors in this area.  I need opportunities like that! 

BAM!!!!

@Patrisha Leybovich will be closing 2 Luxury House Hacks in the next months in AZ. Folks bought my book and reached out. 

The word is spreading. We have kids. We have spouses. We have personal lives that we want to keep private. We want luxury. We don't want to compromise.

Luxury House Hacking all the way!

Thanks for the mention of the book, guys! Available in 3 formats on Amazon. House Hacking :)

@Erin Spradlin Thanks for the comment.  We are doing a month-to-month lease with him in the back. He wanted a longer lease, but I wanted to make sure that he would be a good fit for us. So we only did a month-to-month lease. We considered doing Airbnb, but my wife felt better about having a tenant that we have screen around our kids since we have a shared back yard.

 Originally I wanted to do an Airbnb. But we found out that there were some hotel laws in the city of Burbank that may get in the way of that. Also, our goal was to bring in $1500 a month for the property and we got that with a longer term tenant so we were happy with that. 

That makes perfect sense. Sounds like you're killing it without the short-term rentals. 

I do need to make a correction to the title of the article. I calculated giving myself a $24,000 raise because originally I was going to have the tenant just write checks out to my mortgage company without us receiving it and have it look like we were just splitting the cost of the house payments like someone might do  splitting the cost of lunch. Those that would lower my yearly expenses by $18,000 which is equivalent to giving myself a $24,000 raise. 

But then I talked with my CPA about it  and it is more complicated than that with reguards to ownership and liability and other things like that. So he suggested that I not do that in order to lessen risk. 

 But he said we would be able to deduct all of the repairs and everything else associated with having the guest house including a portion of the utilities and whatnot. 

 I am not sure how everything is going to pencil out with regards to taxes, but I would like to retitle this article how I increased my income by $18,000 through house hacking. 

Well done and welcome to the 'not all househacks are plexes' club @Shiloh Lundahl !

I've had mine for 10yrs so far and it has a lot to do with my not having a w-2 in so long. Sounds like more freedom to me!

I would disagree that it is all taxable and the rent is akin to ordinary income.  Without my  mother-in-law rental, I wouldn't be able to deduct any mortgage interest at all (I'm well below $11k/yr), I wouldn't be able to deduct yard work or half the water/sewer/garbage fees.  Not to mention it is passive and not subject to SE.

Biggest benefit is your primary is now an actual asset that will put money in your pocket when paid off.  Mine will forever bring in more than maintenance, taxes, insurance etc will cost.  Congrats and thank you for sharing this part of your story!      

Congratulations to you and your wife on this successful strategy, even if it's encumbered by the usual tax and life penalties! 

I'm still in the read and collate phase but it's nice to get back on here and check out people who are DOING as well as planning. 

Continued success to everyone in the community! 

Jeff

What were your costs and logistics of permitting the DADU?  Or is it even required in your area?

As someone who is looking to buy their first rental property, do you have any tips or strategies that are best when starting out?

Congratulations on your success! I hope to be like you one day lol!

Shiloh, even if the $18,000 you receive in rent is all profit (it's not) you are still keeping more after tax than you would with w2 income.  You are saving about  $1500 by not having to pay ssdi on that income, double that if you are self employed. 

Nice work. I am looking at something similar for my long term plan for house hacking in the valley. I am hoping to find an off market deal where I can add an ADU (since it is ministerial now), live in the ADU and rent the main house (in a nutshell).

@M.C. Nachtigal We had to paint the outside of the guest house. We also had to take out a tree and put grass down in the backyard. We had to purchase a cooling unit, furniture, and get some repairs to the outside and the bathroom done.

It's looks really nice now.

@Dylan Ramsay @Scott Trench has a new book called Set for Life that talks a lot about great ways to start out investing.  He mentions house hacking in his book as well.  

The past 2 primary residences that we have purchased have both had guests houses.  I don't think I will ever purchase a primary without a guest house ever again.  It just makes sense to me to create an opportunity to make money or lessen expenses by renting out a portion of the primary residence.

We have also purchased 2 buy and hold properties that have had guest houses on them that we are leasing with options to buy.  We have leases with the tenants in the primary house and they can rent out the smaller houses to family or friends to help them pay the monthly lease payments.  This has been really attractive to tenant with relatives who live with them.