Has anyone started on a rehab before they actually closed on the property? I think I know the answer but what the he!!
Nate-WI
Hi Nate,
On my first rehab I actually started three weeks before closing, I put in the contract that I could take possession immediately. It worked out well.
JOhn
But…was that a FISBO? This one is bank owned that I’m closing on July 7th.
Nate-WI
Yes it was FISBO. Tell the bank that you need access to the home for all your inspections, etc, etc. Not sure if that will work or not, but it wont hurt to ask them. If you don’t ask you wont receive.
Good luck
John
Is that actually legally ok to do that? I would thing it would be a bit risky say if you had a fire, or damage of some sort and you didn’t actually own it and had started to rehab it. I don’t know just me but who would you recoop your losses from? Also, what about liabilities during this time period??? Graciez
Exactly my concerns. If I were to bring my contractors in for work and something happened…i.e they fell, fire, property stolen, etc. The easy choice is to wait until closing and then proceed. This is such a light rehab I just want to get it done and back on the market in the same month,
Nate-WI
Also, what if you had such and such work done, spent X amount of dollars, and then the closing fell through? I think its worth it to wait a few weeks.
Nate,
Aren’t you paying cash for this project? I was under the impression you were paying cash for the place, so most likely your closing will take place and not fall through, right? My title company will give me the title report in a matter of days, so I’ll know if the title is clouded or not. If the title checks out ok I start my rehab.
I just did a short sale last week. My bank is gonna fund the project for me once the ARV appraisal comes in on Monday, they loan me 80% of the ARV. I allready talked to the appraiser yesterday and he said it will appraise where we thought it would once it’s updated. If the title check comes back clear I’m starting the demo on the rehab, before closing.
Nate, your contractors should have insurance so if they were to fall, get hurt or have stuff stolen their insurance will cover them.
I agree there is some risk in it and I do think that waiting for closing is a safer way to go. I’m not no 20 year veteran either and I’m learning everyday but I have done 4 deals (on my 5th) in the last 10 months with no problems. Maybe I’am some what wrong or just a risk taker.
July 7th is right around the corner, if you’re uneasy with it just wait it out and get at it then. I like the 3-4 week head start I get because I save on that monthly payment the faster I get it done. Before I start the rehab I allready know I have funding, a clear title and permission from the sellers to take possession and start the rehab. On my last rehab I went and got construction insurance right away which covered fire, hail and wind. The only thing it didn’t cover was theft. Just have the contractor take his tools home with him everyday or tell him he is responsible for them if he leaves them there.
John,
I’m not paying cash for this deal. A local bank is financing this one for me. I just love those little banks. Interest only at prime, 9 month note, 600 bucks for closing costs. Can’t beat them. My funding is a lock and it for some ungodly reason it doesn’t go thru I will use my credit lines to pay for it. It sounds like you have a good system that is working for you. I know you have been working hard out there in NM so keep it up.
Nate-WI
Nate,
Yea those local banks are nice to have on your side. My last rehab was a 6 month loan and the one I’m currently working on is a 12 month loan interest only. It works out great!!!
Glad to hear you found a local bank to use for your REI adventures, you never told me that, or if you did I didn’t remember. I knew you had lines though.
I’m pretty excited about how things are working out for me down here. REI has been really good to me for the last 10-11 months, really good!!! I’m trying to get a system dowm so things work on auto pilot for me so I can focus just on finding the deals.
You keep it up as well. I know you’re well on your way up too!!!
JOhn
Hey guys,
I am fairly new to this forum, but a very experienced rehabber. Own 11 rental units at the moment and growing steady.
First off, no, you shouldn’t start a rehab before you’ve closed on it. With that being said, Ive done it many times and will do so in the future. When all else fails, just play dumb. Usually it’s not that difficult to persuade the existing title holder that I am actually doing them a favor by rehabbing the property early (Dont do any extensive demo work at this time… they’ll freak out, trust me). If you do for whatever reason have the financing fall apart they’ll be getting all this FREE work done! That doesnt work, give them a few more G’s earnest funds, that’ll shut them up.
Secondly, do you guys get taxed as Real Estate Dealers, according to the IRS? Real Estate Developers? Both of these designations are highly unfavorable when it comes to taxes, especially if you’re running a sole proprietorship or an LLC being taxed as a limited partnership (which is default, I believe). Rehabbing properties and selling them within two years (the two year rule isn’t a written rule, rather just a guideline) is a sure sign that you’re a real estate dealer or developer as far as the IRS is concerned. That means you’ll have to capitalize all rehab costs and holding costs over the standard 27.5 year residential depreciation timeline, as opposed to “expensing” the rehab/holding costs in the year it was purchased.
There are quite a few other bad things about being considered a real estate dealer/developer in the eyes of the IRS. The biggest is that you will be held accountable for a 15.3 percent self-employment tax in ADDITION to your ordinary income tax (25 to 33 percent, usually). If you haven’t already done so, I would definitely have two companies - one to hold your rehab or “flip” properties in which your intent was to acquire said property for resale within 2 years, and one to hold your long-term true investment properties in which you take depreciation and collect passive income from. The rehab/flip business structure should be an S-corporation or an LLC which has elected to be taxed as an S-corp. The other should be a standard LLC, where all taxes are the responsibility of the members of the LLC.
I could go on for days about this stuff, and most of it is bad. The IRS can and will go back up to 5-7 years. If you hold all your properties in one LLC, including your rehab/flip properties, and you are found to be a dealer by the IRS, they’ll most certainly state that ALL of your properties are then subject to real estate dealer status and it will become your burden of proof to prove to prove them wise. What you thought were expenses or deductions will be wiped out and reclassified as capital expenses needing to be deducted over 27.5 years (39 for commercial), and you’ll be held liable for any penalties and late fees.
So… are you cowering in a corner ready to cry yet? Don’t fear. The real estate tax law is the way it is to provide loopholes to encourage real estate investment, not deter it. There are all sorts of tax credits available out there as well, such as rehabbing a structure build prior to 1936 earning you a full 10 percent tax credit on all expenses for that structure. So if you spent $20,000 on the rehab, you’ll get $2,000 directly taken off the taxes you owe for that year. Not just a deduction, a CREDIT. That’s huge! Renovate a property designated by the city/state/county or whatever and that tax credit doubles. Retrofit a property during a rehab to be wheelchair accessible and you get a full 50% tax credit off the entire cost! (Before you get too excited about these credits, please note that you must hold onto these properties for at least 5 years or else you’ll have to recapture the tax credit).
Cover your asses, because when push comes to shove the IRS will win. Ive seen countless entrepreneurs become excellent contractors/rehabbers only to lose most of it somewhere down the line because they didnt understand the real estate tax laws and the IRS pinched them. If you really are one of those guys living on the proverbial “edge” and enjoy gambling, at least make sure your business entity is in the form of an S-corporation. The audit rate for S-corps is somewhere in the .28% range, so you have about a 1 in 400 chance of being audited. LLCs are about 1 in 200, and Sole Proprietorships are about 1 in 30.
Carpe Diem!
Visual,
the newbies are waiting for your e-books. Talk about passive income!
I’m going to be a wholesaler, and hopefully, so successful that I am considered a dealer. I digress.
You stated:
That means you’ll have to capitalize all rehab costs and holding costs over the standard 27.5 year residential depreciation timeline, as opposed to “expensing” the rehab/holding costs in the year it was purchased.
I’m a little lost on this one. How does one take thos expenses on a depreciation timeline? I know the math, I think I"m just at a loss how expenses would be depreciated. They’re not assets.
You mentioned the 15.3 percent self-employment tax. Is this tax on gross income? I would have contributed more to my retirement account … now that I’m thinking about this, I’ve answered my own question. Anyway, suggestions to reduce the self employment tax? (given that if i pay it to Soc Sec., it’s not likely I’ll see any of it? lol)
just a thought, but i would say along with risk of not closing and then being out of pocket for work done, liability in case of accidents, or acts of God, if you look at using any contractors would they even being willing to do this without you being the legal owner of property. if i were a contractor i wouldn’t, there would be no legal recourse for lien if payment was not received.
Visual put a whole new spin on this topic. WOW.
Learn about 1031 Exchanges and get professional advice from your CPA. From what I understand, property held as an investment qualifies as 1 year and a day. This will qualify that property for a 1031 Exchange. If you do NOT do a 1031 exchange and sell the property after 1 year and a day you will be taxed at normal captital gains and NOT ordinary income which is about 15%. Ordinary income tax would be about 28% or higher depending on your income bracket of course.
If you somehow live in the property while you fix it up which is another strategy you could enjoy completely tax free income if you live in the property 2 years out of 5 where you would be completely tax exempt up to $250k for single and $500k for married.
I just thought I should add to what Visual has already mentioned. None of these forums should be classified as legal advice.