Rent first then flip?

Question

I've been considering a strategy of buying properties that I can rent out (with minor rehabbing), continue improving the property while it is a rental (taking advantage of the business expense tax deductions) and then in the future do a flip quality renovation and sell the improved property.  What are some things I need to think about when exploring this strategy?

Account Closed · Answer

The tax situation is better on the ones you hold for awhile.

My advice is to be very selective about what you improve. Tenants tend to tear up everything you've done, and it you aren't careful, you will end up doing the work twice.

Do all the work on stuff the tenants can't reach: new roof if it is needed (OK, I have had a tenant tear the roof off, but they don't normally damage the roof).

Repair sidewalks, do structural work, repair the plumbing, perhaps a new heat source if needed.

Get the landscaping under control, but dont improve it. Tenants will likely kill whatever landscaping you do.

Then cosmetically, go cheap on new flooring and paint, because that will all have to be redone when you are ready to sell.

When it is time to sell, you remove the tenant damaged flooring, upgrade to better stuff, add some pots of flowers, do a new paint job, and it should  be close to ready to go back on the market.

Oh, and screen your applicants very carefully. If you are tough about your criteria, you can rent to tenants who do minimal damage. Be careless, and a bad tenant can do $15,000 damage or more in a  very short time.

Jordan Shane · Answer

Thanks guy for the info i was thinking about doing the same thing.

Mike V. · Answer

Dale,
This is exactly my current strategy with SFRs.  I have a full time job so no need for quick cash or even significant cash flow.  I'm happy if I can make a couple hundred a month over principle/interest/taxes/ins to help cover all the other expenses.  I plan on rehabbing/selling whenever the market turns and only pay long term capital gains.  Great advice in the earlier post about putting money into the areas such as roofs and mechanical systems not typically abused by tenants.

Now is a great time to buy - have fun!!

Dale Line · Answer

You guys have been great.  Thanks for the advice!  Dale

Richard Warren · Answer

This has been a part of my business model for years.  I purchase distressed properties and rehab them enough to rent them.  When I am ready to sell I will complete the rehab and liquidate the property.

What you need to watch for is that you do not pay too much or underestimate the amount of work needed.  Those are the two most common mistakes that new investors make.  You also need to be sure that the properties will provide adequate cash flow to cover your expenses.

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Dale Line · Answer

Thanks Richard!  That makes sense.  Folks seem to be focused on either rentals or flipping  - - so I was wondering if there is something I'm not considering by combining the strategies, such as a more negative tax situation.  About how long on average do you hold the rental prior to flipping it?

Richard Warren · Answer

You are more likely to have a positive tax situation.  If you are flipping properties quickly you are considered a â€œdealerâ€ by the IRS and subject to self-employment taxes AND you will be taxed at ordinary income tax rates on your profits in most cases.  You may be able to avoid some of that by operating as an S-Corp. By holding them as rentals you get to take advantage of the depreciation deduction and can also be eligible for long-term capital gains treatment at tax time if youâ€™ve held the property for more than one year.

The hold time varies by property, can be as short as one year or many years.  I currently have several rentals that I will finish rehabbing and sell when the current tenants move.  However they have great cash flow and I donâ€™t really care how long the tenants stay.  I can do that because I have several other sources of income and I am not in need of the money that those sales would generate at this point.

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