How many of you are using ARM loans for fix and flip projects?

Question

I'm currently looking into 3/1 ARM loans (2.65% interest from local credit untion) to purchase and sell some fix and flip houses, rather than a a conventional 30 year fixed loan (3.9% apr)  to save on interest rates. Since I plan on flipping the house within a year or two, it seems I would benefit more in savings from the lower interest rates offered through ARMs.

I was curious how many investors here use ARM loans for their fix and flip projects? How was that worked out for you? ARMS aren't that risky if property managed, right?

Once I sell the house; I can pay off the loan in it's entirety and reapply for a new ARM loan for my next project. Does this sound like it would work? I can still do the 1031-exchange if I payoff the loan and get another loan to buy more investment properties?

Thanks

J Scott · Answer

Starting at the end of your question, you not be allowed to 1031 a flip property, even if you hold it for a year or two.

Next, are you planning to live in the property while you renovate it?  If not, why would you spend a year or two doing the flip?  A lot can change in the market in a year or two, and you add risk when you do long projects like that.

Finally, unless you're planning to live in the property (and even if you're planning to live in the property), federally insured loans are rarely a good choice for flips.  The biggest issue is that most flips are distressed, and to qualify for a typical FNMA/FMAC/HUD loan, the house needs to be in move-in-ready condition -- few flip houses are.

Ryan Murphy · Answer

@Tony K. - I'm in Seattle and just looking around for ARM rates - do you mind telling me which credit union you got your rates from?

J Scott · Answer

Any profits will likely be taxed as ordinary income at your marginal tax rate.  In other words, whatever you'd pay if it were income from a job.  You'll also likely be on the hook for self-employment taxes (FICA).  I would talk to an accountant about how to minimize taxes, but generally speaking, flipping incurs a HIGH tax burden.

As for the loan, I would talk to your loan officer.  You may find that they won't be willing to make the loan if the house is distressed.  But, without knowing the specific loan product, I can't tell you exactly what they'll be looking for.

Chris Mason · Answer

For properties you intend to sell relatively quickly, ARMs often make sense. But really what you should ask about is what the highest lender credit you could get, regardless of rate or fixed v ARM, that will be compliant as a QM prime loan.

Let's say you can take some atrocious interest rate, like 5% or something, but get a $7k credit towards closing costs. Let's say you're paying $200/month more due to that higher interest rate. Let's say you sell the property after seven months.

You will pay $200*7 = $1400 more during that seven months, but you saved $7000 at closing, and came out $5600 ahead.

Basically this is the inverse of the normal logic whereby if it's your "forever" home that you are going to grow old and die in, it generally makes sense to buy the rate down a bit. This is your "sell it as soon as humanly possible" home, so you invert the logic and take "negative" discount points in exchange for a higher rate. You can think of it as the lender buying points from you, if you wish.

Not all ARM products offer interest rates high enough to yield a substantive lender credit.

Dave Foster · Answer

@Tony K., I know this has devolved significantly from a discussion of financing rates.  But you've got everyone all excited now.

You're not using "fix n flip" in the normally used manner.  For most folks fix n flip means that your intent when you buy the property is primarily to resell.  That usually involves rehab that releases already existing underlying value and an immediate resales.  That's going to get all kinds of folks excited saying you can't do a 1031 on it.  And they would be right.

But, it sounds to me like what you're actually doing is buying undervalued properties with the intent to "hold for productive use in business, trade, or investment".  This intent doesn't preclude an eventual sale (remember the guy who is always ready to sell anything - at the right price) but it does involve some uncertainty around when the best time to sell would be.  And usually there is a deliberate strategy to take advantage of what the IRS describes as "the incremental increase in value".  We call that appreciation.

So, whether or not you decide to do a 1031 in a year or two (something I think would probably be fine if you just drop the word "flip" from your vocabulary) By thinking of this as a hold and annual evaluation you'll not only get the defer through the 1031 but you'll get capital gains treatments on property you've held for more than a year (as a hold not as a property you purchased primarily for resale).

The repair isn't what makes it a flip.  It's whether your primary intent is immediate resale or hold.

Derek Daun · Answer

I'm definitely not an expert, but my understanding is:

• If your intent is to sell the house in six months, it won't qualify for a 1031 since the property is not a rental, it's a flip. In addition to income tax, there might be other taxes since you are technically in the house retail business, and the property is actually inventory, not capital equipment.
• If your intent is purchase the house as a rental, but in two years you will reevaluate the market, and based on appreciation, gentrification, and interest rates, sell it if it makes sense. Then the property is a rental, and qualifies for 1031.
• If your intent is to flip the house, but wait for two years in order to qualify for a 1031, it technically doesn't qualify.

Notice 2 and 3 are very similar, just stop calling yourself a flipper.

Adrian Chu · Answer

Yes if you do light cosmetic flips, a conventional ARM loan may work.  Keep in mind though, it will be difficult to compete effectively against cash or hard money offers that aren't contingent.

Tony K. · Answer

After more reading on BP ; particularly Amanda Han's blog post about taxes and flipping ( http://www.biggerpockets.com/renewsblog/2014/07/10...)  ; I understand if the property could qualifies for a 1031 exchange if it's intended purchase is to have it as a long-term rental.

But for those investors that are repairing houses, are you using ARAM mortgages over 30 year fixed? I imagine many would be.

Tony K. · Answer

I did some research and found that if I hold the property as a rental for some time after rehab (not specified in 1031 exchange); I can then sell and qualify for the 1031 exchange.  (http://www.atlas1031.com/blog/1031-exchange/bid/62...)

..  but it may make more sense to just flip and pay capital gains taxes as that is what most investors are doing?

If I keep the property and sell within first year, I would have to pay upwards of 35% capital gains taxes. If I sell the house in the second year, there's long-term taxes 15%. Hm expensive.

After more reading; it sounds like if I live in the property for 2 years or 760 days; I can possibly sell and do the 1031 exchange. Repairs can also be deducted from the capital gains taxes if property recorded, and avoid self employment tax assessments (as an investor)

Tony K. · Answer

@J  ScottHey Scott! Thanks for answering questions about 1031 exchange not being allowed for flip properties.  So I should expect to pay the capital gains taxes on the house after it is sold? (First flip) Is there a way to avoid that by structuring the deal in a llc that would have tax benefits?

I am not planning to live in the property during repairs. and the rehab should take 6 months or less (Was just planning to use 5/1 or 3/1 Adjustable rate mortgage so definitely plan to sell it before interest rates may change was what I meant)

Again not living in property, I wasn't planning to use HUD or FHA programs as I wanted to flip the house asap and not have any live-in criteria. ARAMs are not federally insured loans I thought?

Thanks,

Tony

How many of you are using ARM loans for fix and flip projects?

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