John Schaub’s
Strategies and Solutions
Celebrating 39 years of providing quality information to investors in single family homes and notes
Written for students of Building Wealth One House at a Time
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# 1603 \March/April
TO SELL OR NOT TO SELL?
The issue is all about selling. There is a time to buy and a time to sell. Now is a time that you
can sell at a retail price in most markets. That is not always the case. Just a few years ago, banks would only lend to perfect borrowers, and would not lend to an investor or speculator. Most sales were all cash and that resulted in low offers and prices. Now many can qualify for loans. Even those who had foreclosures or short sales can qualify if they have the income.
I can only teach you part of what you need to know in a few pages. Peter Fortunato and I will teach a comprehensive two-day class on selling April 23 & 24. See details on the back page and at http://www.johnschaub.com/schaub-seminars/
SELLING AT THE TOP
The most asked question of 2016 is “are we near the top?” Many areas of the country have strong seller’s markets. Prices have now risen about previous highs in some markets. The average time on the market is shorter than normal and the inventory of houses for sale is below normal. Easier credit is allow marginal buyers to qualify. Speculators are bidding up prices. So are we near the top? First let’s agree that it’s pretty hard to sell at the top and buy at the bottom. Rather than try to catch either extreme, recognize that there are markets for selling and markets for buying. Obviously the current market is for selling. With that said a more
important question is should you sell now, just because you can?
It’s more complicated than just looking at the market. If you own houses in appreciating neighborhoods that attract good tenants and that operate at a profit, is it smart to sell them? Certainly there are good reasons.
1. You need money to spend, to pay off debt, to upgrade other property 2. The neighborhood is changing for the worse: prices are trending down.
3. The house is worn out: should you spend the money to upgrade a tired house or sell it? When you spend cash to upgrade a house, you often pay retail prices for labor and material.
The result is that you only increase the value of a house by a fraction of what you spend. When you buy a house that has been remodeled, you might be able to negotiate a below market price, and then sell your tired house to a buyer looking for a project.
4. You are tired of managing or not managing well: some landlords enjoy their work into their 80s. It is one job that you can keep for life if you want it. However, measure the quality of your work. Tired landlords sometimes stop raising rents to avoid losing tenants. They may defer maintenance, or begin paying too much for maintenance. If you see this trend, maybe it is your time to begin selling. You invested to make money to enjoy life. Don’t let management become a worry that takes away from that enjoyment.
5. The house is far away: if you own a property in a far-away town, you have to weigh the benefits or cost of holding it against selling it now. If you have a loss, you may consider selling it for a loss that could offset the profit you could make from selling another property for a gain. 6. The house loses money: with a losing property, be aggressive in selling it. Take a loss today and be free to pursue another opportunity rather than try to squeeze a few more dollars out of a losing investment. It may be a loser because of bad financing, bad construction, or bad
neighbors. Unless you can fix it quickly and at a cost that makes sense, sell and buy another better property.
BAD REASONS TO SELL
Selling at the wrong time is as expensive as selling for the wrong reason. Don’t sell a property that makes you money every month. See below before you make an impulsive decision to sell. 1. You have an empty house: If it has attracted good tenants in the past, don’t sell, hold it. If it does not attract well behaved, long term tenants, then selling an empty house is better than selling one with a tenant in it.
2. No leverage: I have had financial advisors tell me that owning free and clear properties is a terrible idea. Your rate of return is low. They are right to a point. What they do not consider is that if you own 10 houses, you can own 5 of them free and clear and 5 with loans and increase your rate of return with the leverage.
3. No depreciation: If you own a house long enough, you will run out of depreciation. If the house is in a great neighborhood and making you money, keep it. Would you sell a stock that goes up every year and pays a big dividend? NO, and stocks have no depreciation. If you want more depreciation, buy more property; don’t sell off your winners.
STRATEGIES TO SELL FOR THE HIGHEST PRICE
Start with a clean house that is freshly painted and has nothing wrong with it that might scare away a buyer. In a seller’s market, you can get away with selling a house that needs a little work that “has potential”. In a buyer’s market, the best-looking houses will sell first. Paint, clean and replace worn floor covering. A spotless house will get more looks.
A full remodel, opening up kitchen spaces, new kitchens and baths will help you sell faster after you are done with the remodel. However, remodeling often takes months and the costs often run over budget. I try to avoid full remodels as the cost plus the time lost, typically offset the increased net price I can demand. If I am going to net about the same amount, I’d rather sell “as is” sooner.
SELLING DIRECTLY TO AN OWNER
As a reformed Realtor, I know how to sell a house. If you have never sold a house, then the process of getting a contract signed, and getting it closed may be intimidating. If you have the skills necessary to sell, then put a sign in the yard to see if one of the neighbors or one of their friends or family might be interested. If you are uncomfortable with the process, you can hire an agent for a flat fee that will help you get the contract completed and executed, or you can hire an attorney. Either way, if you save a 6 or 7% commission, you should be way ahead. Knowing what your property is worth and what offers that have recently been accepted is a reason to talk to an agent.
SELLING THROUGH AN AGENT
If you want an all-cash sale, listing with a talented agent can be the path to a high price, especially in a seller’s market. An agent should be a better salesman than you are and, of course, will be familiar with the current contracts and laws relating to selling. In short she should get you more money faster to compensate for the commission that you will pay.
Interview at least two agents, and more if you don’t feel that one of them will work hard to get you your price. Ask both for a CMA (Comparative Market Analysis) that should show what houses in your neighborhood and similar to yours: (1) Have sold for recently (2) Are on the market now (3) Are pending (under contract) (4) Are off the market. If their CMA does not include this information, interview another agent.
Go see these houses and look them up on the Realtor website to look at pictures of the interior. Compare those houses to yours. Look at time on the market and the price they sold for
compared to the asking price. With this information, you can set a price range from the lowest you will accept to a retail price where you might start.
competition that may bid the price up. When a house is on the market for a long time, agents begin to think something is wrong with it. The older the listing, the lower the offers.
Should you get a low offer right away, counter a price that you are willing to accept, leaving room for one more counteroffer. If your house is priced at $275,000 (with your bottom price at $250,000) and you receive an offer of $245,000, counter at $265,000 to see if they will meet or exceed your bottom price. The first buyer is often your best buyer so your chances are good that they will be excited about the house and raise their price.
THREE NUMBERS YOU NEED TO KNOW WHEN SELLING: 121, 1031, & 453 If you recognize these numbers then you know that these Internal Revenue tax code sections that can help you avoid or defer taxes when you dispose of property.
Section 121 allows you to sell your personal residence and exclude up to $250,000 or
$500,000 in gain depending if you are single or married. To qualify you must own and occupy the property as a principal residence for two of the five years immediately before the sale. However, the ownership and occupancy need not be concurrent.
Section 1031 allows you to sell and reinvest the proceeds of the sale in another investment property and defer the tax due. By exchanging, you can also defer the recapture of
depreciation.
Section 453 allows you to sell your property and collect your profit over several years using an
installment sale and paying the taxes as you receive your profit.
Plus the current estate tax law allows you to leave up to $5,450,000 to your heirs without estate tax. A husband and wife can leave twice that amount. With good planning, you can avoid paying income tax on the gains on your properties by using all of these laws to your advantage, and your heirs can both inherit tax-free and then sell the property without paying any taxes.
Although most tax advisors know of these laws, few understand how to combine them to avoid paying taxes. The laws are straight forward; the strategies can be anything but.
SELLING TO AN OWNER-OCCUPANT WITH SELLER FINANCING
Owner financing, where your buyer makes a down payment and then pays you monthly payments until they pay for the house, is similar to selling with a lease option with a few important differences. When you sell a house using owner financing, regardless of the paperwork that you use, you have a sale for tax purposes.
That sale can be treated as an installment sale if you qualify. An installment sale allows you to report your profit as you receive it, not all in the first year of the sale.
house they have fixed up and are selling. If you are a builder, or flipper, any sale of your inventory does not qualify. This is an important point.
You must elect to take an installment sale and file IRS Form 6252. Check with your accountant for details. See IRS Publication 537 for a complete explanation.
An advantage to the buyer is a lower down payment than a bank would require, and lower closing costs. The seller needs to be able to judge whether the buyer has the income to make the payments. The Dodd Frank Consumer Protection Act of 2010 has regulations that apply to those who sell more than one house a year to a homeowner with owner financing. It does not apply to sales to investors. If you want to sell several houses in one year and finance them, sell to investors.
Should the buyer stop making payments be aware of the cost to get the buyer out of the house and out of title? This may require a foreclosure. Foreclosing, like evicting, should be used only as a last resort. It is nearly always cheaper and faster to negotiate with a buyer who can no longer make their payment and to buy out their interest rather than pay an attorney to have them evicted or foreclosed.
I recently sold a house to an owner occupant who had $10,000 to put down on a $150,000 house and was willing to pay 8% interest on an amortizing loan; the payments are $1,027.27 a month. This house would rent for about $1200 a month and, would have about 40% in
expenses for a net rent of $720 a month. We traded a rental house for a $10,000 check plus an extra $300 a month. It was a house we did not want to keep so both sides were happy.
ACCEPTING A SMALLER HOUSE AS A DOWN PAYMENT
If the house you are trying to sell is a “move up” home, than it is the likely buyers a will already own a smaller house. An excellent way to make a deal is to accept their existing house as a down payment on the house you are trying to sell.
If the buyers like your house, they don’t need to sell their house before they can buy yours. Car dealers discovered the solution to the same problem years ago. You don’t have to sell your old car before you buy a new one, it’s easy; they will take your old car in on trade. Do they make money on your old car? Sure.
You can make money taking a house on trade. Remember the seller is thinking that they will have to pay a commission and perhaps reduce their price to get their house sold. If you simply accept it as a down payment, they can avoid the trauma of having hundreds of people walk through their house making disparaging remarks, before receiving a low-ball offer.
If your house is more expensive and you can accept their house at a retail price as a down payment on your house at a retail price, and make a profit.
Your house for sale - price $225,000
Their house – market value $140,000
You accept their $40,000 equity as a down payment on your $225,000 house. They get a new loan for $185,000 ($225,000 less their $40,000 equity).You get their house subject to their loan and $185,000 in cash at the closing. If you have a loan on your house, it would be paid off with part of the proceeds.
If they have a loan on their property you need to decide if you want to assume it or take title subject to the loan if your plan is to resell it.
If the house is not one that you want to keep, consider selling it on a one-year lease option. If you take title subject to, this is a good strategy, because you have a plan to pay off their loan in a short time (one year or less.)
If you are contacted by the seller’s lender, you can explain that the house is sold and the new buyers are working on securing financing. It is exactly what a lease option buyer should be doing. They may have a year to close, but they should not wait to start qualifying for a loan. In fact, I set up a meeting with a lender before I agree to sell to them to see what they need to do to qualify for a loan. Unless they have a good chance of getting a new loan, I won’t sell to them on a lease option. If they have a credit issue that can be fixed, I’ll take a chance on them. SELLING AND REIVESTING WITHOUT PAYING A TAX ON YOUR GAIN
If you are going to sell and then invest in other investment real estate, you can defer paying any tax until you sell by making an IRC Section 1031 tax deferred exchange. Note that the new property must be held for investment. It does not have to be the same type of investment
property. You could sell a house and buy a duplex or commercial property or even land that you planned to hold as an investment. The replacement property cannot be your personal residence or a vacation home.
If you exchange with a related party, more rules apply. Related parties include (but are not limited to) a spouse, child, grandchild, parent, grandparent, sibling, or a related corporation, S corporation, partnership, trust, estate, or tax-exempt organization (See IRS Section 1031(f). Related parties seem not include stepparents, uncles, aunts, in-laws, cousins, nephews, nieces or ex-spouses.
Corporations, limited liability companies or partnerships in which more than 50% of the stock, membership interests or partnership interests, or more than 50% of the capital interests or profit interests, is owned by the taxpayer is considered to be a related party.
Related parties who concurrently exchange properties with each other must hold the properties for two (2) years following the concurrent 1031 exchange. Both related parties will recognize their respective depreciation recapture and capital gain income tax liabilities if either party disposes of its respective property within two (2) years after the simultaneous 1031 Exchange or transfer.
If you plan to use IRC Section 1031 to defer your tax, have the next property that you want to buy identified before you sell. Section 1031 currently required you to identify your
extensions are allowed. The 45 days goes by quickly, so knowing what you want to buy and even having it under contract will improve your chances of completing the exchange.
Get good legal and tax counsel to insure that your paperwork and strategy comply with the IRS requirements.
Depreciation Recapture: If you sell an investment property then you will owe recapture tax on the depreciation you have taken, which is 25% of the amount of depreciation you claimed. Check with your CPA. You can avoid the recapture tax by using successfully completing a Section 1031 exchange.
If you have properties with large gains most of your profit is due to appreciation, so the amount of depreciation you have to recapture will be less significant. If you buy a house worth $150,000 for $100,000 and hold it until you sell it for $300,000, you will only have depreciation to recapture on the part of the $100,000 which you have depreciated.
In addition to not paying taxes, an exchange forces you to reinvest your profits into another property. Keeping your investment capital invested continuously makes a huge difference in your net worth in the long run.
Join John and Peter Fortunato
Selling To Improve your Cash Flow and Your Life
Is Now The Time? How To Get the Highest After Tax Profit?
Tampa, FL
April 23 & 24, 2016
Holiday Inn Tampa Airport Westshore
$595 seminar registration
Early registration savings: $495 if registered before April 15th $895 for two pre-registering together before April 15th
Class time 9-5 both days. Networking and brainstorming Saturday after class.