Exit strategy: Sell vs Rent out

Hi all,

I’m a beginner in REI and I’m closing on my first investment property in ~10days. It’s a foreclosed townhome appraised for ~$80k for tax purposes last year (sold for $85 in 2007) that I’m getting from REO for ~$44k. The townhome was built in 2005 and needs cosmetic repairs only (paint, carpet, water heater replaced).

I’ve done a lot of reading on this site and forums and got spooked by high taxes if I went with my initial plan for rehabing and selling (flipping) the property ASAP. To my understanding the tax rate comes out to almost 50% with the self-employment tax.

questions #1: do I need to pay self-employment tax of 15% even though I have another primary source of income (military)? I’m in lower tax bracket because my housing and substinence allowences, and Im wondering if my profit tax would still come out to 35%?

Due to high taxes, I’m thinking of doing minor cosmetic repairs and renting it out, possibly to a section 8 tenant, for going rate of $800/month. I would refinance as soon as I can at $65k or so to take my cash out just so I can start working on another property. With renting, my cashflow would be ~$250/month before refi (I’m paying 20% down on the property). The only con for renting is that the subdivision seems to be attracting poor families and I’m hesitant to count on appreciation, even long term. The surrounding location is ok and seems to have a lot of potential.

Please advise and let me know your experiences with refinancing: how soon can I expect to refi? up to what LTV figure can I plan on getting refinanced? Any possible hurdles with refi? Thoughts on refi vs. HELOC.

I appreciate your input!!! :beer

Talk to your local banks to see what they can do for you. They’re generally more flexible than a big corporate type bank (B of A, Wells Fargo, etc) and have bankers who can actually make a decision without pushing your application up to eight levels of bosses above them. We bought a property with cash, fixed it up, started renting it out, and were able to pull all our money out of the house. We do commercial loans and usually get financing to cover purchase cost and rehab.
You should do a search on here for the “50% rule.” There are tons of posts about it and you’ll see a way to estimate real world expenses vs. thinking your cash flow is anything above PITI.

Welcome to the board!

If there is a HOA, they might not allow Section 8. Can’t blame them for not wanting their building turned into a slum.

Decide before you start to rehab. You use different materials for a rental than you would use for a property you want to sell.

As far as I know, you don’t pay self-employment tax on real estate capital gains. In fact, the gov won’t allow you to use real estate income to qualify for SS-- one more complication; you have to be careful to provide for your own retirement, which includes your own medical.

I suggest that you talk to a real estate lawyer and Real estate accountant about the taxes. There is state tax, too, PLUS if you are in military, you probably also owe taxes in your state home of record.

But think… 50% of $40K profit in your pocket beats paying no taxes on $0 and nothing in your pocket.

Thanks for replies.

I’d love to hear your opinion on another option I came up with last night: what if I do a quick, cheap fix-up, rent the property out while staying under $50k after all expenses with $35k mortgage, and then setup a HELOC of up to $40k that I could use for future investments.

HELOCs are better than cash-out refi since there are no or little closing cost, dont need seasoning period (???), and can get higher LTV. Not sure, however, if I could use HELOC as downpayment on another property of up to $120K.

Please let me know what you think :rolleyes

P.S. had an inspector come through today and condition of the premises is better than I expected. I just need to make up my mind on exit strategy and the grade of materials/level of repairs. Closing is nearing fast…

Be careful with calculating your ARV. With the market being a the state of flux that it is now, using tax appraisals or sales from several years ago is NOT a good method for calculating value. The only true way is to research sales of comparable properties within the last couple months. The reason I warn you is that I got burned on a couple properties lately because I anticipated by value based on the factors I just mentioned and then the current appraisal came in WAY lower.