BRRR strategy - question about the last R
My friend has 2 houses. The 1st house was bought in 1999 for $45,000 and he bought it with cash, lived in it while he re-modeled/repaired it, and then bought a 2nd house in 2012 for $100,000 with a conventional home owner's 30-year loan, which he moved into in 2013. He now has rented his 1st house out at $875 per month the last two year and that house appraises for $100,000. His home owner's insurance and property tax bill comes to $2,600 per year. I was just sitting down with him at dinner and going over the numbers:
1st house: rental income of $7,900 per year(net rental income) - $1,975(federal tax rate of 25%) = $5,925 ; cash-on-cash return is $5,925/$100,000 = 5.95%
2nd house: $75,000 conventional home owner's 30-year loan with 4% interest (he already paid off $25,000 of the initial loan) = $3,000 per year payment to bank
Net income = $2,925 to pay off the principal of the 2nd house's loan.
I told him he would be better off getting a real estate lawyer and/or accountant to help make sure he gets his depreciation deducted from his 1st house in order to increase his cash-on-cash return. I also thought it would be better for him to cash out refinance his 1st home to pay off his 2nd home. Is it called a home equity loan or what is it called? Here are my numbers on my suggestions:
1st home: rental income $7,900 per year (net rental income) - $1,066(federal tax of 25% on $4,264 since $3,636 is tax deductible due to depreciation [$100,000/27.5 years]) - $3,000 (new home equity loan yearly payment at 30 year 4% rate) =$3,834; cash-on-cash return is $3,834/$25,000(home equity loan cashed out 75% of the value of the house to pay off the 2nd house) = 15.3%.
2nd home: paid off
Net income = $3,834 per year to put in stock market at average annual return of 9-11%, which compounds annually.
Does this make sense to the experts on this forum? Please critique.