Set to Inherit San Diego property: Build, Rent, or Sell?

Question

Hey guys! New to investing and Bigger Pockets, but super eager to get started on the journey. My husband and I have spent the last few months reading all the books and listening to all the podcasts, essentially going down the rabbit hole as most rookies do. We have been trying to decided which asset class will be best for us in our local market (Willamette Valley, OR). However, we keep coming back to the potential that the best first deal actually lies in a property that my mom owns in San Diego. A little background on the property ...

My mom purchased it for $340,000 in the 90's in cash, no mortgage on the property.
Now estimated at $1.2M as is. It's a 1 bed, 1 bath that hasn't had any updates done since purchasing. Surrounding similar lots have been redeveloped into $2-3M homes.

I obviously need to rehab/build a house on it to bring the value up to its potential, but I'm not sure where to start with this? Who do we reach out to first (builder, appraiser, architect, lender)? What are the steps to transforming this 1 bed/1 bath shack of a house into the best investment possible?

After the rehab/rebuild is finished what would the most lucrative option be? To hold and long term rent?  Short term rental given the location? Sell and do a 1031 into further investments?  Here are some numbers we pulled from AIRDNA and Zillow to help weigh options.

AIRDNA:

As is (1bed/1 bath): Projected Revenue $50k/year, Net Operating Income $24k/year

Post rehab/rebuild (3 bed/2 bath): Projected Revenue $120k/year, Net Operating Income $76k/year

Zillow Rent Estimate:

As is (1 bed/1 bath): $2,900/month

Projected rent based on comps in area: $6,500/month

We would also more than likely include an ADU in the new build. Both to maximize profits (two rents) and incase we need to use the property to care for aging parents in the future.

Another thing to consider:

My mom is planning on giving me this property as my inheritance but was considering just gifting it to me before she dies. However I read about "step up in basis" and how we could avoid capital gains tax on all of that appreciation if she just leaves it to me after death. Along these lines, I am wondering if it is more lucrative to go ahead and increase the value of the property as much as possible now, rather than waiting until I inherit it?

Any advice on the steps we would need to take to turn this into an opportunity for our family would be so appreciated! We have been tossing ideas around for a long time, and we thought who better to ask than our new Bigger Pockets community.

Thanks in advance!

Lauren

Katie Balatbat · Answer

@Lauren L Pokladnik

You're smart to begin thinking about this, and looking at it from all angles.  Just adding a couple of things for you to consider to add to your research -

Regarding the basis step-up, you're correct that under current law, your mom holding it until her death may allow for you to receive it with a full stepped-up basis, washing out all the appreciation during her lifetime.  Conversely, gifts generally take a carryover basis.  In your situation, that could mean significant differences for eventual income taxes. (income taxes)

Additionally, the question of whether to hold until death or gift may also depend on the size of your mother's taxable estate and where you believe the estate tax laws to be headed.  Carryover basis for gifting is one major consideration, but you may also wish to consider what transferring the value of the property now at a relatively lower value would do for her taxable estate and any possible estate tax owed at her death.  If her estate is fairly low in size, perhaps this is not a major consideration. (estate taxes)

And, you may wish to look into how your basis would be calculated when you start to develop and build and re-hab the place.  If you're going to completely raze what is there now and build anew, you may wish to see how that would affect your basis and eventual gains, too.

Finally, don't overlook property tax implications.  I'm sure that your mother pays very low property taxes right now due to Prop 13 in California.  There are certain rules in California that allow for that very low assessed value to be transferred to a child, but the rules are pretty restrictive in nature.  Thus, if you do not meet the current rules, you may wish to be prepared for a reassessment for property taxes, which could change your cash flow analysis drastically. (property tax)

Hope this adds some additional points for your consideration.

*This post does not create an attorney-client or CPA-client relationship.  The information contained in this post is not to be relied upon.  Readers are advised to seek professional advice.

Brian Koons · Answer

Hey Lauren, I am a developer in San Diego and pretty active in the market. I'd love to take a look at the property with you and see what development potential there is on it. Knowing what you can do first helps determine what strategy makes the most sense. Let me know if you'd like to chat!

Max Reynolds · Answer

Hey Lauren - love to hear that you guys have the gears spinning and are ready to embark on your real estate journey! Your return on equity is very low based on those numbers provided so yes, some action needs to take place whether it be adding square footage, new construction, or 1031ing. My recommendation would be speaking with a local agent/property manager who has personal experience with investing in San Diego real estate and can complete a property analysis for you to determine current value, highest and best-use, and what your options are. If necessary, then connect you with an architect, builder, lender, or your CPA to discuss tax implications. Something else to consider is your current financial position as construction/renovations requires capital.

Steve Meyers · Answer

@Lauren L Pokladnik the first thing I would do is get a feasibility study done on your lot to decide what can be built on it to determine highest and best use of your lot and the cost that is associated with that.  There are a lot of developers in SD that will partner with you on something like this and help out with the capital.  It's ideal that you own the property outright because the holding costs on a hard money loan a lot of time is what kills development deals.  You can find a couple of capital partners to come in and help out with cost for permits, plans etc.

I'm not a developer myself but I know a few who are doing these types of projects throughout SD and would be interested in partnering with you.  Send me a PM if you want to chat about this further.

Ben McMahon · Answer

@Lauren L Pokladnik

Hey Lauren, we actually run into this type situation pretty often in San Diego, and seen people do it different ways.  I wouldn't dare advise on a tax strategy, but as far as the building itself goes, it will probably depend on what your goals are.  Big construction projects take a lot of time and money, but can also be super lucrative if done right.    Happy to chat.  Just send me a DM

Kristi Kandel · Answer

1. If you're willing to wait you could talk to a tax/asset management strategist on how to officially setup the entities to avoid the capital gains.

2. There are ways with trusts and transfers upon death that lock in the value of the property at time of death. What that means is after you have your plan from #1 upon death the value of the land is set at current values. Then you can sell that property and you'll only be taxed on the profit ABOVE the value at death. AKA making it beneficial to improve the property prior to death to maximize value. Since "inheritance" is something that is a gift and "unearned" to the person getting it this is a great way to create a great source of tax free income in your retirement.

3. Why would you do that. B/c there are other ways to make proceeds from the property / leverage it as a long-term play where you can get tremendous upside on the back end vs taking possession now.

4. There are definitely nuances for how to structure this properly. I'd recommend reaching out to Cheri Hill for a conversation. She's been in this space her entire career and has been an educator on this topic as well. She works nationwide and I have no affiliation with her other than knowing she's an amazing asset to helping you narrow down your strategy.

Cheri S. Hill, “Wealth Protection Diva”Sage International, Inc.

(Celebrating 31 years in Business!)

1135 Terminal Way Ste 209, Reno NV 89502

775-786-5515

www.sageintl.comwww.CheriHillShow.com

Lauren L Pokladnik · Answer

Thank you all for taking the time to provide your thoughts! It can be overwhelming trying to navigate this situation and knowing where to start. You’ve all given me some good insights and I really appreciate it! Cheers,

Lauren

Set to Inherit San Diego property: Build, Rent, or Sell?

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