All Forum Posts by: Joe Splitrock

My CPA just informed me of a large tax bill on my rentals. It is called making a profit. That is despite claiming all sorts of expenses, mileage, home office, cell phone, repairs, capital improvements, interest and accelerating some depreciation. 

Keep in mind that interest rates have been exceptionally low and your two biggest deductions are usually mortgage interest and depreciation. Rents have also been climbing, but if you acquired a property years ago, depreciation is fixed. You can find expenses, like remodeling or painting to help create expenses, but that cuts into profit. You can accelerate depreciation on new purchases, but that only helps temporarily. Once your accelerated loss is realized, you have less depreciation in future years. You are not avoiding taxes, just shifting the burden to earlier years. That can be a big surprise in the future when the tax bill comes due. 

Don't feel bad, making a profit is good. The best thing I have found to help generate expenses is keep acquiring properties and keep up on improvements. Then you are growing your portfolio and protecting the quality of your assets. Having more income helps cover taxes too. Taxes will only increase in the future for investors. With the TCJA, we are the lowest point you will probably see in your lifetime and TCJA will expire. 

 I have seen appraisals less accurate than Zestimate. Keep in mind the appraisers just use an algorithm based tool like Zillow. The only difference is they manually manipulate the data. That can be good or bad. They can make arbitrary determinations of finish quality and cause your value to be much lower. Appraisers also have a tendency to appraise almost exactly at purchase price. That is not a coincidence, they know the price so they are biased. Real estate agents also use comps for price comparison.

The problem with their iBuyers offers business wasn't their valuations, it was their offer relative to valuations. They should have been offering 60% of market value like a wholesaler of flipper. It varied some, but they were generally offering 85% after fees and repairs. They didn't build in enough cost for unexpected expenses, carrying costs, valuation variance and selling fees. Their strategy going in was taking a loss to get the business off the ground. They should have had profit expectation day one and scaled slower. They were expecting 3% margin when the business matured. 

I am not sure if you have ever claimed a home in Zillow, but you can modify the comparable properties it is using for valuation. If you do that, it can be highly accurate. Like any valuation (realtor or appraiser included), it all comes down to comparable properties. In this market it is actually hard to estimate value. Look how many houses sell for far more than listing price. Realtors are shocked by how much a property can sell for. Ultimately valuations are an estimate and the market determines what it is worth.

Zillow is pretty accurate for an algorithm based price estimate. There is two ways it will not be accurate:

1. If your property details are not accurate. If your square feet is wrong or other property details are incorrect. You can edit these if you claim ownership.

2. There needs to be comparable properties. If your house is in a subdevelopment with 100 other near identical houses, Zestimate is very accurate. If your house is very unique, then it is harder to compare. 

I know real estate agents will tell you Zillow sucks and Zestimate is inaccurate, but then they turn around and use algorithm based tools to analyze your price for listing on the MLS. Their tools just pull up comparable sales, exactly the same as Zillow does. The only difference is they human intervention to manipulate incorrect data. You can also do that on Zillow. There is a screen where you select comparable properties from a list of available recent sales. If you do that, your estimate can be more accurate. It can also be less accurate if you are picking unreasonable comparable. People have a tendency to believe their house is worth more than it is. This is where a real estate agent can sometimes deliver an impartial reality check.

It is tough because on the flip side (no pun intended), flippers also drain the market of affordable housing. The areas they revitalize are made more expensive, which prices people out of the previously affordable neighborhoods. The same thing happens with BRRRR and tenants getting displaced. The dirty little secret of "affordable housing" is that the housing is affordable because it is old, run down and out dated.

I am all for the free market and I don't support this tax. I was just trying to point out that taxes often just increase costs for buyers. I don't like any attack on business and California does nothing but attack business. Yet they turn a blind eye to property tax freezes, which penalize new buyers. There is far too much moral superiority by people sitting in houses worth $2M and saying that flippers are the problem. They are happy to cash out on the higher values when they sell. 

I am not really convinced that this tax will even hurt flippers. One of two things will likely happen:

1. Flippers will demand lower acquisition price on distressed properties.

2. Flippers will demand higher sales price on rehabbed properties.

So if this doesn't hurt flippers, it hurts sellers or buyers. Just like increasing taxes on corporations doesn't hurt corporations. It hurts share holders or raises prices for customers. I think people who propose these taxes have good intent, but don't fundamentally understand how business or the economy works. They believe taxing a flipper will drive flippers out of business or make more houses available to owner occupied. 

@Seth Young people can make a lot of money on fix and flip's in California, because of the high selling prices. You may rehab in middle America and pay $80K, then sell for $250K. In California you may pay $800K and sell for $1.5M. Even if the margin is lower in California, it is lower margin on a higher basis, so total profit dollars are much higher. Even with all the problems CA has, their housing market is exceptional. 

I agree with @Joe Villeneuve sell it and use it as seed money to leverage into a larger portfolio. One reason to do this is because you will own no taxes. If you convert to rental, there will likely be tax burden in the future. @Brittany Snyder taxes will be one of your biggest expenses as an investor or more specifically as a successful investor. Always thing of ways to minimize taxes. Leverage is your largest advantage in real estate, so always thing of ways to maximize leverage. In case you are not familiar with the terminology, leverage means using debt (loans) to buy real estate that is proportionately larger than your available cash down payment. The term leverage means "to gain advantage" whether that is mechanical advantage or financial advantage. It is doing more with less using tools.

Request an estoppel prior to closing. This is a document completed and signed by the tenant and landlord. It basically just states terms of agreement:

Name of occupants / address

Monthly rent amount is X

Term is month to month

Security deposit is X

I would refuse to close without this document. It is common for selling landlord to claim no deposit or no lease, only to find later the tenant says there was a deposit and produces a lease. Just type up a simple estoppel agreement based on the information the landlord provides and have the tenant/landlord sign it. Explain to the seller that this eliminates surprised later that can arise from verbal agreement. 

If they refuse to have the tenant sign something, then the seller still needs to sign something specifically attesting to deposit, term of tenancy and monthly rate. That way if there is a dispute later, the seller doesn't just claim "I never said that". People who do agreements verbally are either dishonest or disorganized. Either way, it is sloppy landholding and who knows what other shortcuts they took.

 When you walk into closing, you will be asked to sign paperwork attesting to the fact that nothing changed financially. You have to disclose your resignation and lack of income to your lender. Or were you trying to say that you did disclose lack of income and they wont close the loan? This is a tough situation because of underwriting requirements of traditional mortgages. This means you will not qualify for many loan products. 

You will want to look for DSCR loans potentially which use income of the property as part of the qualification model. Another option is use cash to establish your portfolio, then refinance after you develop a track record.

 Depends on if the actual water pipes are separate between units. Often in fourplex, all the piping is mixed so it is not possible to meter separately. There may be one or two water heaters feeding the entire building, etc. The other option is RUBS billing where you assign a percentage of the water bill to each unit based on size or occupancy. I personally think that is too much hassle and hard to make it fair. Whether they pay $1000 rent and $50 water bill or pay you $1050 makes no difference in the cost of living in the unit. The only advantage of separate meters is that it encourages conservation. You can do that other ways, like increasing rent and telling tenants it is due to high water usage. Installing low flow shower heads, low flush toilets, low flow faucets are other ways to reduce usage. Also consider what is common in your area. Most apartments and fourplex in my city include water and garbage (many even include heat). If you are not including comparable services, your rent price needs to be lower. 

The HELOC is secured against your primary residence, but is an expense of your investment property. Once you rent out the property, you really have two choices:

1. Pay the HELOC using rental income.

2. "Refinance" the HELOC into a fixed rate and term mortgage.

As long as you spend the HELOC on an investment property, the interest from the HELOC is deductible against income on that investment property. So the HELOC or rental property mortgage is different than your primary mortgage. I say different because the expense is paid from rental income and you deduct the interest against your income on taxes. Think of it as a business loan and business expense.

So no the HELOC will not roll into a mortgage, but you can use mortgage proceeds to pay off the HELOC when you finance. Also note that this technically is not a refinance of the rental property, because you never had financing secured against the rental property. You technically paid cash for the rental using money borrowed from your HELOC.