After finishing rehab for a flip, what do you do next?

Question

Hi all,

What do you do after you finish rehab on a property that you intend on selling? I see a few options and want to hear what you do and whether you have any other good options. The point I want is to reduce taxes, because flipping houses doesn't make sense any more on higher marginal tax rates and end up being a waste of energy and focus in my opinion.

1. Sell right away - higher taxes

2. Rent for a year, then sell

3. Lease to own, with the option to sell after 1 year

4. Rent for a year, then do a 1031 exchange

And for those that decide to rent it out for a year, do you refi right away to get money out so you have cash to deploy to another project, or do you think that's too much of a waste on fees since you'll get your money out within like 10 months anyways?

J Scott · Answer

Under each of those scenarios, the taxes are the same. When you buy house that you intend to renovate and resell, you will pay ordinary income taxes at your marginal rate, regardless of how long you hold it or whether you rent it before selling it.

And a flip doesn't qualify for 1031 exchange, so that's not an option either.

All that matters to the IRS is your original intention for your exit strategy.

Dave Foster · Answer

@Allen Li, @J Scott is right that your intent if you want to do a 1031 must be to hold for productive use. And even more importantly thought it's how you can demonstrate that intent. And you may have purchased it intending to resale. But by default, if you hold an extended period before you sell you are by action demonstrating an intent to hold for productive use. And in this instance a 1031 would be fine. Your original intent may have been to sell. But you will clearly demonstrate a change of intent. There is no statutory hold period but most folks feel comfortable with anything more than a year. That would indefinitely defer all tax.

You will want to demonstrate a clear change of intent from resell to hold. This is where a savvy CPA is worth their weight in gold.

Allen L. · Answer

@Dave Foster Thanks Dave, that makes sense. I suppose that means lease to own and sell after a year would be considered "flipping" since that's clearly the intent in the L2O contract.

David Da Silva · Answer

I only buy and hold for this reason. Even though many of my clients do flips, I consider flips a job moreso than an investment since clearly the main goal is usually to profit on the resale vs anything else.

The benefit on buy and holds is you don't worry about taxes aside from property tax, which is being paid by tenants anyways. Not to mention you have room for appreciation so your chance of pulling out more equity can increase along with the rents if you buy in a high demand area.

Not sure what your deal looks like, but if you're rents look good, maybe a cash out refi is a better option? You can get up to 80% LTV depending on the loan and none of the tax penalties from selling.

You can always decide to "Flip" at another time.

Hope this helps.

Kelly Watkins · Answer

Have you consulted a Realtor or looked at comps to see what you could sell the property for right now? The inventory is SO low you may be able to make enough profit to make it worth the tax bill. If you rent for a year it's not uncommon you will then need to do additional rehab to the property as renters can be hard on properties. Since you started your post by saying your intention is to sell I say sell & move onto the next one! =)

Dave Foster · Answer

@Allen Li, Options are not generally seen as a clear demonstration of intent unless they line up with something else that sways it one way or t-other. An option may or may not be exercised. Now a lease with a purchase agreement looks like something else.

And just a tip - if you go the option route have it be a separate agreement to the lease. Keep it as neutral as possible. And do not tie it in any way to the lease. Otherwise you could very well end up giving an equitable claim on the property to the tenant. And now you're having to foreclose rather than evict.

Allen L. · Answer

Yes thanks Scott that makes a lot of sense, and I read a book you wrote a few years ago, it helped me become more comfortable doing rehabs albeit remotely. You mention a good point, which is the original intent of the strategy. I suppose that's why many people BRRRR and never sell, which seems quite attractive.

After finishing rehab for a flip, what do you do next?

After finishing rehab for a flip, what do you do next?

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