BRRRSR strategy - not a typo - sanity check and tax implications

General Real Estate Investing
7yFollow

BRRRSR strategy - not a typo - sanity check and tax implications

Antony Nguyen
Member since 2019 · 4 posts · 0 votes

Hi Everyone!

This post is 2 questions in one, if it's suggested I post these separately let me know!

First off is my investment strategy. I have some capital to work with and can buy residential properties with cash. My goal is to find good deals, acquire with cash, rehab, rent, refi, and sell. With the refi money I pull out, I would add that to my working capital to do another cash purchase and repeat. I guess you can call this a BRRRSR strategy. The reason I want to buy single properties instead of putting down payments on multiple properties is that I am looking to buy at foreclosure auctions which of course require full cash payments. I can get a good deal, but the number of purchases I can transact is limited by the capital I have.

Here's a scenario that's pretty close to what I'm trying to accomplish:

1) acquire property with an ARV of $350K for $200K cash.

2) rehab, place tenant, season for 6 months

3) after 6 months, do a cashout refi based on ARV $350K, and pull out ~$262.5K. Here's the math, ignoring fees: with a 75% LTV mortage, 75% of $350K is $262.5K. Since I paid cash initially, this cashout is very large compared to partial down-payment investments. My net profit on top of the original $200K investment is $62.5K.

4) wait at least 2 years

5) after 2 years following the cashout refi, sell property at around ARV, $350K

(I am actually skipping/combining a part where I do a Delayed Finance loan to get 75% of my money back asap after the initial acquisition, then do the cashout refi based on ARV after 6 months of seasoning).

My first question is, are the above steps sound, strategically speaking? I am a newbie investor and want to know if the above math sounds right, or if I'm missing something and my numbers are wrong, specifically if the cashout amount is correct, again ignoring fees. For multiple reasons, I do not want to keep the property for more than 2.5 to 3 years, but am willing to keep the property for a couple years, as I've seen comments here on BP that selling quickly after a cashout refi raises eyebrows at the IRS.

Ultimately, I'm trying to buildup a pile of cash within a certain time frame to do larger commercial investments with higher potential gains (this part I'm sure about - don't try to convince me to stay forever in residential haha).

Assuming the fundamentals are correct, the next question is that of taxes. Let's say I sell the property at the ARV that the cashout refi is based-on, and I don't profit from the sale. I did however make $62.5K on the cashout (plus rental cashflow). My question is, is the cashout money ($62.5K) taxable in any way after the sale takes place? Obviously if I were to make a profit on a sale (say $375K sale price, $25K selling profit), I would want to 1031 exchange, but for the purpose of focusing on the cashout, I just want to break even on paying off the mortgage, thus no sale profits.

Any feedback on the above questions would be greatly appreciated! 

0Reply
30 views

5 Replies

Jump to latestLatest
  • Brian G.
    Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
    7y

    @Antony Nguyen yes the above could definitely work. However it wouldn't be very cost efficient to do two refis within 6 months of each other (delayed, then cash-out based on ARV) since each closing would probably cost approx. $3k. Why not wait and just do one cash-out refi based on the ARV? Regarding taxes, you will be taxed on the gain of the property (sales price + closing costs minus your cost basis [purchase + rehab prior to putting property in service + some closing costs] as well as pay the depreciation recapture tax. The cash-out refi has no bearing on your taxes at the time you sell but you are of course able to write off the interest paid on your higher loan amount after the cash-out refi. Technically your net profit would be the sale price including closing costs minus your total "all in" cost to put the property in service. The $62.5k is in essence taking some of your profit in advance in the form of a loan instead of waiting until you sell.

    0Reply
  • Antony Nguyen
    OP
    Member since 2019 · 4 posts · 0 votes
    7y

    @Brian G. - thanks for the reply!  I agree that doing two refis close together would cost me money.  I intend to do a couple acquisitions in a short time period and I need a good chunk of my cash from the initial acquisition to go into the second, so to me the fees associated with multiple refis is just a cost of doing business.  I have very good credit and decent W2 income so I am confident I can get loans on 2 properties within 6 months of each other, but if you think or have seen otherwise, let me know!

    And as for taxes owed, just to repeat for my own better understanding:  I should not be taxed on the $62.5K cashout from the newer $350K refi loan, and I can write-off interest on the $350K refi loan.

    On a sale, I would be taxed on any additional sales profit on top of $350K I get for the sale (or taxes will be deferred with 1031 exchange).  

    Is this correct?

    0Reply
  • Brian G.
    Rental Property Investor · Los Angeles, CA · Member since 2013 · 1k+ posts · 1k+ votes
    7y

    @Antony Nguyen yes, you can do a cash-out refi and get the $62.5k in your hands and pay no taxes at year end. It's treated as a loan, not as profit and therefore yes, you can write off all the interest paid on the new higher loan amount. And yes, on a sale, you are taxed on the difference between your cost basis (ie total purchase to put the property in service) and the sale price. The tax liability on this gain can be deferred with a 1031 exchange.  

    0Reply
  • Antony Nguyen
    OP
    Member since 2019 · 4 posts · 0 votes
    7y

    Brian, just saw this now, thanks for the reply!  I will let you know how things turn out.

    0Reply
  • Wayne Brooks
    Real Estate Professional · West Palm Beach, FL · Member since 2012 · 23k+ posts · 13k+ votes
    7y

    @Antony Nguyen To make sure you understand.....the refi’s/loans that you have, in whatever amount, nor any appraisal have Nothing to do with the taxes you will owe.

    In your example, ignoring fees/financing costs....

    Buy for $200k, spend $35k on rehab, sell for $350k (say $325 after commissions and closing costs)....

    You’re into the property for $235k

    You sell (net of costs) for $325k

    Your taxable gain is $90k ($325k minus $235k)

    It makes no difference if you did this all cash, refi’d 16 times, and somehow got a loan for $350k.....none of that affects your gain.

    Also, the irs doesn’t care about selling quickly after refinancing (since refinancing doesn’t affect profit/taxes, unless......you refi right before a 1031, the. They consider you to have “taken out profit already” since the 1031 delays the taxation of that profit if you reinvest all the proceeds (and just “took the profit out with a refi”).

    0Reply
Join the conversationCreate a free account to reply, vote on answers and follow this thread.
Log InJoin for Free