rehab, or sell as is?

Question

My sister and I inherited a mortgage free house appx. 1yr. ago in San Diego, 1955, 8900 sq. ft lot. 3bd/1bth 980 sq.ft, which has now become vacant. I am trying to decide if It is worth trying to rehab, or sell as is. current value appx.450- 500,000. ARV range 600-800,000. Looks like 50,000 would get it to the 6-650 range. 75-100,000 up to 800,000+ range.  I am concerned that after selling fees, tax's, it may eat up too much profit. My credit is not great, so wondering what loan fees will be as well. This is a up and coming area, with flips happening all over. I do have extensive experience in construction, landscaping, and design. Any advice?

Bruce May · Answer

The cool thing is you have so many options with the house. It sounds like your end goal is to sell it and you're deciding if you want to invest the time and money for a higher return. Your CPA is probably going to be your best bet on any tax questions. I'll give it a go with the main question.

Regarding a remodel, lets say you didn't want to wait for a bank to loan you the money and you went with a hard money lender. Most, like us, charge around 10% and around 2 points. So if you borrowed $100k to do a top end remodel and it took you 12 months you'd pay around $2k for the points, and it would cost you about $834 per month for the loan, or $10k if you needed the money for the whole year ($10,000/12 = $833.33/mo). There will be some other small loan fees as well, but nothing that would shock you. You could actually borrow more money than needed to help cover you loan payments while you do the rehab.

The comparison is selling at the high end for $800k or the low end for $450k, correct? $450k less any costs/fees is what you and your sister will net, which depending on how you sell it could be a straight $225k to each of you minus your fees. IMHO, it might net each of you about $200k when it's all said and done and that's what you pay tax on. Selling the house for $800k will net each of you $400k minus your loan and fees. Deduct $112k for the loan and you are now at $688K. Then start deducting your sales fees. If I use 10% then it's another $80k, and you and your sister each get $300k and you pay tax on that. So in my crazy ballpark guess the difference is $100k for each of you if it's a 50/50 split.

You have to decide if you want to pay tax on that extra $100k and if it is worth the year to wait. Now I could be very very wrong because I'm just having fun here playing the "what if" game, but you get the idea. Best of luck with your decision.

Dan H. · Answer

your question presented selling options only.  One thing to keep in mind is that if you choose to make the unit a rental your property tax is artificially low due to prop 13 which provides you cash flow opportunity that someone purchasing the property today would not have.

So I think you should consider keeping the property as a rental.  I suggest at least run the numbers and determine if it is the correct option for you.

If after running the numbers, taking into account prop 13 savings, renting is not for you then you will have analyzed the option and any decision would have evaluated all options.

Good luck

Daniel Lepore · Answer

There are already a lot of good ideas here, but one point to clarify in regards to taxes is that when you inherited the property, you received a step up in the basis of the property to fair value on the date of death (or 6 months later depending on which value was higher).  So if you were to sell the property "as is" today, the taxes you would pay would be very minimal.  I would only consider a 1031 exchange if you added value to the property.

Justin R. · Answer

@Brenda Kinney If you have the time and desire to take on the project, do it.  If you've got more important things in your life, just sell it (or rent it out and decide later).

FWIW, on larger lots (like yours), and assuming it's in the urban part of the City, we've been further developing stuff like this rather than just flipping them - much more capital intensive, but also much higher potential profits.  If you've got all the renovation know-how and just need the capital, private money folks would finance something like this pretty easily.

If you don't want to take on the project yourself, another option would be to partner up - you're bringing the property and you could rely on someone else to shoulder most of the risk and actual work ... and you end up with bigger profits at the end of the day.

Disclaimer: I both lend and partner on urban development projects similar to this one, so I have an interest in doing business on something like this - there is conflict-of-interest.  Regardless, my advice to the OP would be the same.

Brent Coombs · Answer

Third option: keep it as a rental and let the improving neighborhood get you extra value by osmosis,  WITHOUT a rehab! Other than that, read your own fine summary - and decide! Cheers...

Account Closed · Answer

Sell it to some over anxious newbie flipper that is desperate for a deal. They will gladly overpay.

Michael Cooper · Answer

Your tax issue is unique since you have just inherited the property. You're going to have to deal with possible estate and cap gains BUT there's a good chance you will be able to duck under the minimum thresholds for both. Your best path really depends on your, and your sister's, long term goals. Holding it as a rental and keeping the old prop 13 taxes after taking some cash out should be on the table too!

PM me if you like - I'd be happy to sit down with you and pencil it out.

J.R. St Julien · Answer

@Brenna Kinney please PM me. I would love to come view the property and then make a recommendation.

Bill Exeter · Answer

Hi Brenda,

The 1031 Exchange is certainly one option. It would allow you to sell the existing property and subsequently reinvest into one or more Replacement Properties while deferring the payment of your depreciation recapture and capital gain taxes. The process would allow you to reposition your investments into a potentially better cash flowing property.

Sam Shueh · Answer

Clean it up. Repair the most obvious defects or get quotes. This can take 2 months longer to put it on the market if you rehabit yourself.    Most virtual investors do not want to rehab. Take the money and move on.

rehab, or sell as is?

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