The following is a guest post written by Terry Sprouse, author of “Fix em Up, Rent em Out: How to Start Your Own House Fix-up and Rental Business in Your Spare Time” – Find out more at Fixemup.org
In my opinion, the two safest ways to get started in real estate, are: 1) buy a home, rent it, then do it again, and/or 2) buy a home, live in it 2 years, then sell it without paying any federal taxes using the “homeowner’s tax break.” Over the past six years, my wife and I have used both techniques. We have several properties that we keep as rental properties and provide us with cash flow. In addition, we also buy houses in need of repair with the intention of selling them and utilizing the “homeowners tax break” to pay no federal taxes.
Turn Your Residence into a Rental Instead of Selling It
A system that I like to use is to refinance my residence six months to a year before I plan to buy a new residence. This gives me enough money for a down payment on the next house that I will purchase. When I locate a good fixer-upper I can quickly purchase it. During the 3-4 weeks it takes to close on the new house, I prepare the old house so it will be ready to rent. This usually involves some painting and landscaping. Then, before I close on the new house, the “for rent” sign goes up on the old house.
The 3 steps in this technique: 1.) refinance your residence. 2.) use the refinance money as a down payment to buy a new house. 3.) move into the new house and rent out the old house Instead of refinancing your residence, you can use savings or a loan from a relative as a down payment. As mentioned, an advantage of refinancing your residence while you are still living there is that you get a lower interest rate on your loan than if you were refinancing a rental property. Under this technique, you get the lower “primary residence” interest rate for both the old property and the new one, since each property is your primary residence at the time that you take out the loan.
Did you know that you can own real estate in your IRA?
Sell a House that You Live in For Two Years and Pay No Income Tax
The 1997 Taxpayer Relief Act was a great boost for average people who wanted to sell their home and buy a new one. It was also a great boost for investors. Couples are allowed to exclude up to $500,000 of the capital gain on the sale of their primary residence. Single individuals can exclude up to $250,000. In other words, the sale of the house is never reported on your federal IRS forms if the capital gain is less than the $500,000 and $250,000 limits.
This exclusion is based on compliance with two requirements: 1. The home must have been the primary residence for both spouses during two of the last five years. The two years do not have to be consecutive but if you rent out the primary residence for more than three years you would be required to occupy it again for two years. 2. The exclusion is available only once every two years. Utilization of this tax exemption is the safest investment strategy for the conservative investor who wants to take few risks. This is the type of investor who wears both suspenders and a belt to hold up his pants. They like to play it safe.
Under this strategy, the investors can quality for the least expensive loan, the owner-occupied loan. There is no need to worry about tenants destroying your rental property or not paying the rent. You completely control the investment by living in the property yourself. When you sell, you have the opportunity to bring in up to $500,000 tax-free money every two years. My wife and I didn’t sock away much money for retirement, but with our rental houses, we have a flow of income that will last as long as we keep the houses.
Many people stay away from rental properties because they don’t want to deal with renters. However, with practice anything is easy, including dealing with renters, and the rewards far outweigh the difficulties. If you really don’t want to deal with renters, just use technique #2, where you buy and sell every two years. Technique #2 is for people who like to play it safe. I have made real estate investing my hobby, as have many others, and you can do it too. For anyone who wants to learn there is plenty of room in the fix-up business. Grab a hammer and join me.