All Forum Posts by: Paul Novak

BP Community, I apologize if this is a foolish questions but I was hoping someone from a tax perspective could help me answer. 

Why can't I sell my primary residence to my LLC and become a tenant of my business? My business could then pay the utilities, property taxes, mortgage interest, insurance policy, and home repairs. They would be expenses for the business vs. personal expenses which would be tax deductions. I'm assuming if this was an option everyone would already be doing it but I am just curious from a professional to understand why this isn't an option.

I received a question from a friend that was somewhat similar to mine above which got me thinking.  He asked me the following:

"I have a paid off rental house that I earn a good chunk of profit on in 2024. With our new house, we have a large mortgage. I wanted to "sell" the rental house to a new LLC of mine in an effort to create an expense for the rental, and drastically reduce my tax owed. My goal is to generate more expenses on paper with the rental to reduce the taxable income for future years. How can I do that"

Again rather than give advice when I am not a tax professional I figured I would pose his question on the forums to see what response the community would give. 

 James, Thanks for sharing the 55 year old 401K exemption.  I will have to check that out as that isn't something I know much about.  As for our current expenses we are comfortable at $8,000 per month.  The one wild card is what healthcare will cost us in retirement, especially if we retire early.  For that reason I keep maxing out my HSA.  If we can get our rental portfolio to cash flow $11K a month I feel like that is a good enough buffer even if we account for inflation.  One thing I plan to offset my healthcare costs with is paying off my primary residence.  That accounts for $940 per month of my $8,000 expenses.

 Andrew, thanks for reaching out and providing your perspective.  I agree with your comment about inflation.  While I am not banking on it I do think with inflation will come rent increases that will help hedge against it.  For example one property I purchased 4 years ago was a two family townhouse.  I had rents set at $1,000 per unit and they are now up to $1,275 and $1,300.  Now I think expecting that type of rent growth to continue is foolish as the market went through some crazy times over the past 4 years that isn't likely to continue but I do hope to continue to get some growth over time.

One option that has worked for us is taking out a loan against your 401K.  I am not sure what your financial situation is or if you have a 401K as an option to borrow but this has worked for us.  My wife and I have become big fans of this strategy because we pay the interest back to ourselves.  Everyone's 401K rules are a little different but the way it works for most is you can borrow up to $50K or half the total balance, which ever number is smaller.  Then you pay it back over time with payroll deduction.  The max term for the loan for my wife and I is 5 years.  You are assessed interest but it gets paid back to the account and you get to keep it.  There are also fees but they are extremely minimal in my opinion.  For my wife's account we had to pay a $75 one time activation fee and that was it.  On my account I had to pay $10 per quarter I had the loan active.  I paid the money back in 8 months so I only paid $30 total to borrow from my account.  Now you will have to be able to absorb the paycheck hit but it's short term.  For context when we do this our biweekly payments have been around $485 per paycheck so around $1,000 per month of lost income per person when we both do it.  This isn't for everyone but this has really worked well for us.  The other watchout is if you lose your job you are required to pay the money back quickly, like 30-90 days with most 401K's or the loan gets converted to a withdrawal that comes with tax implications and penalties.  If you have more questions let me know but this could be an option.

Jeremy, all good questions. The numbers I shared above were lifetime totals over the course of the last 4 years. We do have W2 jobs and don't qualify as real estate professionals. Our business is structured as an LLC partnership with my wife and I 50-50 owners. Neither of us make over $150K per year as individuals members. I would have to ask my CPA how that works but I believe he told us that helps from a loss perspective with taxes. Either way we will get to claim that money at some point. To be honest it wouldn't be the worst thing if those losses stacked and we could use them when we retire and our income gets reduced. Where that $45K tax number comes from is a combination of three things, the depreciation on the property, the deductions for property taxes, the deduction for mortgage interest, and $16K in lifetime expenses for the property. If I am looking at this wrong please let me know.

The house we purchased for $199,900.  We had to put 25% down because it was a multifamily.  My monthly mortgage is $1,050 per month all in including escrow.  When we first purchased the house rents were $2,000, $1,000 per side.  Now rents are $2,574, with one side at $1,300 and the other at $1,275.  Putting our cash flow at $1,525 on months with no additional expenses.

Thanks Aaron for this post.  I don't have any advice but I think this strategy is interesting and I hope to learn from others who respond to this post.

I want to provide two options.  The first bit of advice I would give based on what I have learned in real estate so far is you need to build up more than $25K.  I honestly feel bad saying that because anyone that has saved up $25K to invest should be darn proud of what they have accomplished as that's no easy feat.  My recommendation would be to put that $25K in a high yield savings account and keep contributing to it.  I am a risk adverse investor who prefers conventional financing on properties which requires 20% down for single family properties and 25% down for multifamily properties.  I would want you to have enough for the down payment of the property, another $5K for closing costs on the loan, and $10K for emergencies with it being your first property.  It would also be important that your property cashflows to sustain the business.  That's my responsible advice.  Having said that I also know that if I wanted to get started I would find a way lol.

Learning everything I have learned now through BP with $25K you could do a house hack.  I am going to make an assumption that you have margin between your income and expenses being that you saved up $25K.  That will be important if you own a property because you might need to divert cash from saving to repairs as a home owner.  If you could find a multifamily property where you lived in one side and rented out the other you could get started in real estate and possibly lower your current living expenses.  Just running very soft numbers if you used $5K for closing costs and used $20K for a down payment with 5% down on an owner occupied property you could purchase something up to $400K.  My market is one hour north and I know properties are more expense in Milwaukee but I think you could find something at that price point.

I would check rents and make sure the property would cash flow if you move out.  In the beginning the goal would be to get into the market so you could start taking advantage of appreciation, tax advantages, and debt paydown.  Also hopefully lower you living expenses.  Long term you would have options to keep the property as a long term rental and move out as you build up more cash.  You could also sell the property and use the proceeds to upgrade rentals.  You won't pay taxes on the gains because it would be your primary residence.  This would give you options.

I feel doing this with only $25K would leave you strapped as it's more risky but it's a way you could get started.

 Thanks for reaching out and providing your perspective.  I do measure my cash on cash return for my business and for each property.  My numbers are really accurate for the exception of the tax portion.  I am confident in my depreciation numbers on the dwelling but I make an assumption that my other tax deductions will all occur in the year that I have the expense when I know my CPA depreciates some of them as capital expenses over time.  While I know this throws off my calculations a bit they are still directionally correct.

Here are the numbers for my first property:

Cash To Purchase - $53,250.25

Mortgage Payments - $43,980.00

Expenses - $16,738.02

Total Cash Invested - $113,968.27

Total Cashflow - $22,041.81

Appreciation - $81,800.00

Debt Paydown - $10,143.12

Estimated Tax Deductions - $45,163.55

Total Returns - $159,148.48

Total Return % = 139.64%

I have owned the property for 42 months so my annual returns have been 39.90%.  I don't think the market will continue to appreciate as it has over the past few years and that equity isn't something I can realize until I sell the property which I don't plan to do.  It's nice but not something I plan to cash in on it as part of my strategy.  As for the tax portion I explained those numbers could be off slightly but overall I feel this still beats the market.

Using the same math my other properties have had lifetime returns of 89.97%, 22.69%, 46.90%, and 34.69%. Because we have been in growth mode acquiring properties with closing costs and rehab costs our business has been operating at a loss on paper each year not having to pay taxes for the business. This year our goal is to payback our HELOC and 401K loans so we won't have the same level of expenses which will leave us with higher tax implications at the end of the year. That will impact our percentages but overall I still feel this has been better than the stock market.

It's a combination of a few things that are allowing us to execute our strategy.  Our pretax income from our W2's is $235K per year combined.  We also live in a reasonably low cost of living area compared to the rest of the nation where the home prices we are looking at for rentals are between $200K and $250K.  In addition to that without having any real debt other than mortgages we are able to live comfortably while saving almost 60% of our income.  That figure is a combination of what we save from our W2's and reinvesting all our profits back into the business.

Quote from @Marcus Auerbach:

This brings back memories! 

My first live-in flip was a distressed 3,600 sqft home, shockingly not old just built in the 90s, but totally shot. I thought my 140k rehab funds were plenty, but I found out the hard way that it would really take $50-$60 per square foot for the interior. 

You do the math.

Plus all the the exterior projects: new siding, new roof, building out eave returns and soffit overhangs to fix the poor curb appeal, un-converting the attached garage, driveway, retaining walls, the detached garage, 144 truckloads of fill to create a front yard, landscaping... 

So outside of licensed electrician, plumber etc I ended up doing as much as possible myself, 5 hours every workday night and sun up to sun down on weekends.

Looking back this was a huge adventure for me personally, it took me 2 years, I learned a lot and it made me a better investor. I did it, because I had no choice, but I would not recommend it.

The pictures below are all (young me) me, including the guy inside the septic system.

 AMAZING!  Thanks for sharing the photo's.  You did one hell of a job!