Take profits from Flip to fund more flips or buy and hold?

Question

Debating whether to use my flip profits into reinvesting in more flips and continuing that cycle until the market cools down and then switching my strategy to buying and holding (when it becomes more of a buyers market), or using some of that money for buy and hold investments now (which is the ultimate goal)?

Dave Foster · Answer

@Jeff Piscioniere, I don't know if that would make banks more skittish - I doubt it.  I was more looking at a comparison. Let's say a $100K loan carries 2% origination fee to get a 5% interest rate.  If you can flip that 4 times in a year you're looking at a very real $8K of origination fees.  that eats up profit.  But more importantly whats a better deal for you - 4 loans @5% that cost $2K each or one loan at 6% that costs $2000.  There's definitely finance cost savings in a buy and hold strategy.  You just have to spread sheet em to quantify them.

But more importantly is the tax burden of the flipper.  Ordinary income plus self employment and maybe the ACA surcharge of 3.8%.  It's very easy for flip income to approach the 40% tax mark.  That tells me that it takes someone 3 flips to equal the gain that I get from one buy and hold that I 1031 to keep the tax deferred.  And I get depreciation and equity build from the tenant paying the mortgage down.

I'm not saying don't do flips.  I have.  They're fun and the cash injections can be very addicting.  And they can be a good kick starter.  But the tried and true long term path to lasting generational wealth is through holding real estate for productive use, taking advantage of every tax write off, transferring the properties tax deferred and giving them to your heirs tax free.

Heather Lutz · Answer

I would suggest to do both. Investing in fix and flips will create the capital to invest in more buy and holds.

Dave Foster · Answer

@Thuy Pham-Satrappe, There's a model where you can do both.  Basically what @Eric Mayer, is doing:  First eliminate the word flip from your vocabulary.  Everything you buy you buy with the intent of holding for productive use.  Then asap you do a refi and pull the cash back out to finance the next purchase.  Meanwhile you're evaluating the refi'd property to see if and when it is time to sell it.  when you sell you are then able to 1031 and defer all the tax into the new purchase which you then refi and use the refi to......etc.

Note - Eric's being pretty aggressive with 6 months hold period.  There is no statutory hold period but most folks feel pretty good at anything more than a year.  However, because intent is the standard and not a prescriptive time period there could be situations where a hold of less than (or more than) a year was appropriate.

It sounds like your pain point is the time to season a property and the potential opportunity cost during that time.  That's cetainly a consideration when ramping up such an endeavor.  However once the train is rolling it becomes self feeding.

You might want to lay out a side by side comparison of opportunity cost vs actual tax cost since flipping is an ordinary income activity which is quite a bit in CA especially.  Of course the added benefit of being able to 1031 and not just pay capital gains but defer all gain and depreciation recapture make a powerful case for slowing down just a bit at the front to gain a lot more on the back end.

Flipping early in a market is like taking a walk on the beach and picking up gold nuggets while you enjoy the view.   As a market matures it becomes more like actual mining.  And at the end of a market the roof supports of the mine get increasingly shaky.  Which is why the security of a strong buy and hold portfolio as your foundation can be a very good thing.

Dave Foster · Answer

@Jeff Piscioniere, I should have tagged you on the above post.  It might be applicable to your situation as well.  Enjoy.

Eric Mayer · Answer

I treat my buy and hold properties as long term flips. Cash flow while I do some renovation. Sell tax free with a 1031 exchange into a larger deal. You really only need to wait about 6 months.

Eric

Thuy Pham-Satrappe · Answer

@Jeff Piscioniere that's interesting because my issue is refinancing a buy and hold in the sense that in the time it takes the seasoning period to pass, I feel the opportunity cost of the money being tied up is greater.  I initially purchased a property with the intention of renting it out but the market has been so hot with lots of opportunities for flips I decided to flip that property instead. (I weighed out the short-term vs long-term benefit in each scenario and the short-term won out in this case).

As far as taxes go that's definitely something to consider because it's taxed as active income on a flip compared to a buy and hold which has more favorable taxation.

Good luck to you!!!

Jeff Piscioniere · Answer

@Thuy Pham-Satrappe I’m trying very hard to convince my 2 business partners to consider doing a flip for the short term purpose of funding our buy and hold strategy. We have cash enough to buy a flip candidate in full but they are both fearful on the carrying costs and who and how to rehab it. From what I hear it’s also not as clear cut on refinancing out either.

I’d love to hear more about your flip business particularly the capital gain tax implications. That seems to be one aspect of the flipping phenomenon that no one ever seems to talk about. Either way, good luck!

Jeff Piscioniere · Answer

@Dave Foster well explained!  I appreciated your post!  So are you saying that a refi could be a touch and go situation if the bank interprets an intent of a flipping business?

Thuy Pham-Satrappe · Answer

@Nick Giulioni I'm brand new to this so diversification isn't a huge issue yet, although that is partly why I want to mix it up with a buy and hold between every few flips.

I turned what was going to initially be a buy and hold into a flip because of the opportunity cost of the money being tied up in that property while I wait to get it refinanced because the return on that particular property was ok, but the use I could put the money to in the meantime was better according to my calculations.

Nick Giulioni · Answer

How much equity are you going to need to fund your buy and hold lifestyle investments? Can you make more by reinvesting in flipping? Do you need to diversify?

There isn’t a right or wrong answer - but I think you need to evaluate what your goals and risk tolerances are.

Take profits from Flip to fund more flips or buy and hold?

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