Changing gears from a flip to a house to live in?

Question

I wonder which BP forum this question is best suited for? Suggestions appreciated. I think it's mostly a tax question?

Here's the sitch...

We took on a significant single-family rehab that for lack of a better term, "hasn't gone great," first intended as a buy-and-hold rehab. When it became a bigger project than we expected, so we decided instead to sell it off after done. Then there were complications, and setbacks, and town/permit issues, and contractor issues and Covid and so on. We've been at this since December of 2018. Yikes. We literally have made no progress from mid December until about 2 weeks ago (mid May). Things are finally back in motion I think it will be done with the last of it in a few weeks. So 1.5 years so far.

The purchase and the rehab is 100 percent borrowed money, mostly off a business credit line we have secured by apartments we own. We are now being "forced" to convert the line to a loan that terms out on a 3 year/balloon with no prepayment penalty, instead of what we were hoping would be just a 3 to 6 month extension on the original credit line. This is how the bank wants to do it, due to their fears in the current economic climate. The subject house does not secure the loan, our apartments do. I am not worried about maintaining the payment indefinitely, but it is an expense that is burning resources as every month goes by. I don't expect the project house to be profitable at this point, if sold.

In considering all options, one thought is to sell the house we are living in and pay this and other stuff off with that money and then (so to speak) buy the rehab house from our LLC and then live in that. I just wonder from a tax point of view if anyone has taken on a house intended as a flip and then went through whatever motions it would take to convert the deal instead into a primary residence?

From an accounting and  tax point-of-view, can I buy the house from my LLC and make it my residence instead of selling it off to third party? With an above the board/legit paper trail and legit transaction to myself, without causing some kind of tax audit or other ugly problems?

Michael Klinger · Answer

Thanks for the replies so far. I am aware that there is a lot to consider in whether there is any merit in this move. To simplify the conversation here, I'd like to ignore if this is a good or bad idea. I'd just like to get clear on the maneuver from a business/tax point of view. To clarify, the borrowed money is secured with apartments that are ultimately owned by an LLC that is structured as a partnership. The two members are me and my wife.

To answer the other question, It is my hunch that the house would sell somewhere between break even and a loss of up to 50K in the open market. But again, I am more interested in how I would structure it, if we decided (for better or worse) to sell our house and live in this one.

Natalie Schanne · Answer

@Michael Klinger - I vote that you list the house, sell it and write down your lessons learned. Take the pass through loss and apply it to your income to reduce taxes. I  think prices are going down for all real estate. Someone on my block just listed $100k below all previous comps and their house was in nice shape. (I didn’t win the offer as is cash closing 14 days). Take the lesson and buy a really good deal or fix up your apartments.

- Keeping it means getting a 30 year owner occupant mortgage and living there for at least one year. Since it is not an arms length transaction, unclear if you would get a purchase loan or a refi loan. If your proven tax return income is good enough, many loans are now 3-3.5% 30 year fixed which is crazy cheap money. I don’t know if you picked things you personally liked - I know with my 2 yr cap gains free tax play live in rehab I chose white cabinets and neutral grey paint throughout instead of personalizing anything in the house for ME.

- If you keep it, it’ll be a constant reminder of mistakes. I met another flipping couple who had been holding their property for a year and hadn’t made any progress in 4+ months after their latest contractor screwed them. I think they ended up bankrupt. In some rehabs we intentionally choose not to do everything because there are some things the buyer values more than other things - trendy paint and fancy appliances vs new windows.

Evan Polaski · Answer

@Michael Klinger, I am sorry this rehab didn't go smoothly for you.  It is infuriating when delays and issues arise simply because someone isn't doing their job (contractor).

Is the LLC a sole member or pass-through entity to your personal returns?

My wife and I bought a house in her LLC to flip, we ended up moving into it instead.  It had a construction loan secured by LLC.  But since the LLC is a sole member (my wife) we simply transferred title and refi'd the construction loan into a personal, owner occupied loan.  There was no tax implication for us because a) it was owned in a pass through entity anyways, and b) the house was essentially "inventory" on a balance sheet and was not effecting income yet.  We were simply booking costs to the asset, until the year it was going to sell.

We also did not assign a purchase price to transaction, since there is a tax abatement associated with it, and selling at "cost" would have raised our property taxes.

Of course, your CPA will be the only one that can tell you how it will effect your taxes to transfer into your personal name and move in.

Matt Groth · Answer

How unprofitable is the project house? Your best bet is to probably just take the loss and get rid of it. By holding on to it, you still have the loss, it just isn't realized. I understand your thinking, but a lot has to go right to make it work.  Waiting for inflation to turn a bad deal profitable isn't the goal.

Changing gears from a flip to a house to live in?

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