*Expenses hurt, *Refi unhelpful.. Personal Tax Returns BRRR

14 Replies

I'll be as clear and quick as I can:

I recently finished renovating a 5 plex and SF house in NE, then subdivided the lot to create two different properties. I then refinanced them with a local bank, success, kind of.

A. Buy: Purchased $100k owner carry for 1 year. I put $10k down to owner. 

B. Renovate: Just over $150k. 

C. Refinanced: 80% LTV, new loan $235k left in deal $15k

D. Repeat: As I am preparing my tax returns with my CPA here's what I am running into. My books now show my expenses -$10k and -$150k to equal -$160k. **The new loan of $235k is not income, so my books show a negative. Stopping my ability to finance another deal. Renovations hurt me and the new loan is not helping. 

Has anyone ran into this issue before? If so any insight?

- I have done 5+ flips but this is my first BRRR. I will be discussing this in a meeting with my CPA next week.

Hey Kent,

Are you doing this in an LLC? I always did all my BRRRR deals in my personal name so I could use my W2 income.

All my lenders I've used, never cared about the initial expense of fixing up the property. They cared about what the monthly cashflow looked like once it was rented - your debt coverage ratio or DTI.

If you have 235k in cash reserves, I find it hard to believe they wouldn't loan you any more money, unless the property has negative future cashflow.

Hope that helps!

Originally posted by @Kent Lord :

I'll be as clear and quick as I can:

I recently finished renovating a 5 plex and SF house in NE, then subdivided the lot to create two different properties. I then refinanced them with a local bank, success, kind of.

A. Buy: Purchased $100k owner carry for 1 year. I put $10k down to owner. 

B. Renovate: Just over $150k. 

C. Refinanced: 80% LTV, new loan $235k left in deal $15k

D. Repeat: As I am preparing my tax returns with my CPA here's what I am running into. My books now show my expenses -$10k and -$150k to equal -$160k. **The new loan of $235k is not income, so my books show a negative. Stopping my ability to finance another deal. Renovations hurt me and the new loan is not helping. 

Has anyone ran into this issue before? If so any insight?

- I have done 5+ flips but this is my first BRRR. I will be discussing this in a meeting with my CPA next week.

 Your CPA can clarify this really fast, but 150k and 10k are not your deductible expenses. You have to capitalize them and depreciate them. 

@Kent Lord No you have no expenses, you have an asset with a basis of $250k. You spent $100k to buy it and $150k to renovate it, that is the basis of the property.

You are confusing balance sheet items, with income and expense items. A balance sheet is your net worth at a given point in time. An income and expense statement is your net income over a period of time, like a year. You can have a high net worth and no income or vice versa, high income and no net worth. A lender will look at both your net income and your net worth.

Right now it is not rented so you have no income nor expenses. You have an asset worth $250 and a loan against it for $235. so you have a net worth of $15k. That is how a bank will look at it.

Does this help make it more clear?

@Cameron Tope

The thing is I’m self employed and my income as a contractor is under the same entity I bought the property with. This was because all my credit cards, employees, and equipment were used under this investment project and other income producing jobs.

Also some of the $150k was leveraged into an $80k line of credit and some other CC’s. So I don’t have that as liquidity.

But yes thank you.

Originally posted by @Kent Lord :

@Ashish Acharya

Interesting, then the expenses would be considered capitol improvements and need to be itemized under that one property?

Yes, kind of. Flips are rentals have different accounitng.  

@Kent Lord the first thing I noticed is you say BRRR instead of BRRRR. The extra R is for Rent. I assume plan to rent these properties after renovation or you would not have refinanced them. Is that correct?

Any expense incurred prior to putting the property in service as a rental are capitalized and depreciated. You paid $100K for the property. The $10K is your down payment, it is not an expense. Basically you take the $110K and the $150K renovation and you get $260K total. You need to split that between the two properties. Let's assume the house is worth $80K and the 5 plex is worth $190K. So you have two properties, each will have it's own section on your taxes. 

Next step is subtracting out land value. There are different ways to determine this, but let's assume $20K for single family and $30K for multifamily lot. So you have two structures that can be depreciated:

Single family $80K-$20K land =  $60K basis

5 Plex $190K-$30K land = $160K basis

You can depreciate residential real estate over rate of 27.5 years. So you divide it by 27.5 and this is what you can claim per year:

Single family $60K / 27.5 = $2181 per year

5 Plex $160K / 27.5 = $5818 per year

In order to claim these expenses, the properties need to be in service as a rental property. That means available and advertised to rent. Assuming they are ready now, you should have some rental income for the year. 

On the new $235,000 loan you can expense the interest, but not the principal payments. 

It is very possible that you will show a loss for the properties. You may be able to deduct that loss from your other income, depending on your situation. If you cannot, then you can forward the loss to future years. All that means is your rental income will not be taxable. I suspect you will not have a loss next year, assuming you keep these 6 units rented. 

Just to clarify again, the $10K down payment is not a business expense. As you said, the $235K loan is not income. Only the interest expense is relevant for taxes. 

Originally posted by Kent Lord:

@Ned Carey

Gotcha so I just need to make sure my CPA allocates the expenses related to the property apart from my overall income?

Rental income and expenses go on Schedule E. There are instruction for that form that show you how to carry that loss or profit to your total income. Each property will be accounted for separately. 

A lot of people have touched on all the right points but here’s my 2 cents. When talking in real estate tax, the amount you pay for a property is your basis that includes your down payment and any improvements you make to your property adds to your basis. Now this could go different ways depending on your strategy, that is are you flipping it or are you renting it. If you are flipping, the basis of your property becomes your cost of goods sold when you sell and that’s when you take it as an expense. This is called capitalization. If you are renting it, you also capitalize and the way you expense the cost of the property is through depreciation.

@Kent Lord

You've had a lot of good inputs here, especially from Splitrock.

I wanted to add if you are going to keep this as a long term rental, you'd best move the Title (and the loan) to another entity.  Usually not a good idea to mix business activities under one entity.  Consult a professional or two. I can see what you are trying to do, but it still would/should have been possible to use a separate entity.  But, its all up to you.  Good luck.

All good advice here - yes please split those entities ASAP!  

Also I've found that not all bankers are equal when it comes to understanding real estate. If the one you have now doesn't understand what you're doing and how the BRRRR method works, find a new one. I find small local banks or credit unions are best.

@Kent Lord

The large renovations that you had may or may not be expensed in 2020. 
They may need to be capitalized.

Regarding your DTI ratio and whether you will be eligible for a loan - some items such as one time repairs, depreciation are normally added back.

Originally posted by @Kent Lord :

@Cameron Tope

The thing is I’m self employed and my income as a contractor is under the same entity I bought the property with. This was because all my credit cards, employees, and equipment were used under this investment project and other income producing jobs.

Also some of the $150k was leveraged into an $80k line of credit and some other CC’s. So I don’t have that as liquidity.

But yes thank you.

Then yes, you'll have to use the same LLC as your income.

Tough spot. But good news, it gets easier!