I am going to pull the trigger on some investment properties soon, but not sure which direction I want to go...

My options:

Condo
Pluses: Less money down, less risk, higher potential appreciation
Minuses: less cash flow (if at all)


4 unit building
Pluses: Positive cash flow (about 2,500 a year)
Minuses: Headache with tenants, double money down compared to condo, higher risk, appreciation less then condo

What else am I missing here? I can also potentially go for a couple of condos vs. one building. I do not want to tap into home equity, so I do have a budget.

 

What's your cash flow analysis?

 

^ Annually, we're talking about $2,000 for the 4 unit, and breaking even/+/- a few hundred for a condo.

 

As a landlord neither of those seem worth doing. $2000 is a horrendous return even with no money in the deal. If you have a single major repair (furnace, roof, etc). you virtually made no money for your efforts of collecting rent and maintaining the building. I can not believe that a 4 unit only clears that much money.

 

I agree with ^^ and I work in real estate too. I may be wrong here, but don't you get to take depreciation on rental property?

 

I am no real estate expert, but that's what I was asking. For 2k a year, it just didn't seem to be worth my time. With a condo, the cash flow is low, but the return is much higher if I sell in a couple of years...

 

So, what is an ideal scenario, or what should I be doing with real estate investing with this time (as I type this, bailout plan on CNN... fck)!

 

How about a bigger apartment building with something like 50 units? You can take a loan for a few million, and pay it off in the next few years with the rental income. After that, you'll be making a nice steady income for life...

Anyone have experiences with something like this?

 

What about a nice duplex?? The value usually holds pretty well on those. Get one of the residents to do some light maintenence and you barely have to go there...

 

Have to remember that when you go to sell any of these investment properties, you will get hit with capital gains taxes so be prepared.

Neither are really worth it in my opinion. The cash flows for both are extremely low for the amount of aggrivation and frustration you might have to deal with. Keep looking...

 

I have a 9 unit mixed-use building with approx. 50% equity with a 20yr mortgage (adjusts every 3 years). It's not a full or even part time job to take care of it, and after all costs/expenses i break even...which is to say that i don't pocket any *CASH* but my equity in the building increases (i put more money back into it than i need to though). biggest short term advantage is my $9k tax return every year due to the building expenses since I still have a full time job that withholds taxes.

In 2 years when my mortgage is going to adjust, i plan to incorporate and refinance to a 30yr fixed to bring my payments down and actually pocket ~$2k/mo after all expenses OR using the equity to pick up another building...we'll see based on market conditions and what other deductions i can make personally (ie kids?) to reduce my salary tax liability.

If you're focused on the long term advantages, it may be worth it even if you're only profiting $2k annually. I plan it so that I don't profit much at all at this point because i'm using it to pay less taxes on my full time income, but long term the profit would be enough to equal a moderate full time income.

 

^ That tax advantage is nice.

 

Just some rough numbers for your consideration, the building generates about $60k per year (should be higher but my rents are way too low and it takes time to raise them without "shocking" the tenant).

$43k - Mortgage
$17k - Depreciation
$10k - operating (maintenance, repairs, insurance, etc...can be closer to $5k if I chose to forgo some improvements)

So out of $60k in rents, I generate a loss of about $10k, although I still put money in my pocket because the ACTUAL money outcome is only mortgage and operating costs ($53k)...the $17k depreciation isn't money out of my pocket per se, just claimable as a loss on my tax return.

So with my full time job salary and claiming a loss on the building, I receive back $8-9k every year from the feds. without the building, I calculate I would get back about $1000 or so.

And if you look into it more, this is how a lot of business try to run...to maintain ZERO profit. They still generate cash but pass this off to employees or other costs so in the end, they end up with ZERO profit and therefore little if any tax liability. It's not saying they aren't makign money, they just don't have a tax liability.

 

How did you determine depreciation?

 

rental property 27.5 year, there's a chart. http://www.irs.gov/pub/irs-pdf/p527.pdf PAGE 14
You don't get hit capital gains if you plan ahead and notify that you're purchasing a "like' property

 

If you mean a corporation then I would form a partnership instead. See below for why:

Basis in building when you incorporate = $50,000
3 years later you decide to end your corporation and the FMV of the building is $500,000. You will have a taxable transaction of $450,000 if you take back the building.

If you did the same transaction as a partnership or LLC then taking back the building is not a taxable transaction. Just FYI.

 

Turbotax Premier

I enter in the numbers (granted I keep very detailed records and receipts), and it spits out the rest.

and to correct a mistake in my previous post...the value I show for "Mortgage" isn't mortgage, it's mortgage interest and tax escrow (pretty much whatever i pay to the bank that's deductible).

 

LLC is the other option, but not partnership. I haven't decided what to do yet, except i need to get it off of "me" for liability reasons. I have to look into it more to see what the liability is, but why do you say the basis in the building is only $50k when you incorporate? wouldn't the basis be whatever the "corporation" pays me for the building (ie to transfer the mortgage to the corporation)? if i sell in the future, the taxable gain would only be the difference between the initial mortgage amount and FMV, which it would be anyway if I sold it on the market. And I think this will be the same whether it's an S Corp or LLC. The problem with LLC is the "self employment" tax on the total income of the company, while an S Corp you can assign yourself a salary and "distribute" the rest, so you only pay taxes on YOUR salary, not the total. But then you gotta deal with payroll taxes with an S corp.

I have a lot of homework to do before I actually go one way or the other, but in the end it'll come down to what I can manage (paperwork-wise) and what is more tax-friendly.

 

Yeah, you definitely might want to consider going into a corporation or LLC because of liability reasons. If someone slips on your concrete, hopefully they wont, they can now sue you for your personal assets, whereas if you had a corporation they couldn't touch you. Plus, you can save some money from taxes in the long term.

 

I didn't even know the an LLC was just an "option" in this case. I'd say you shouldn't go into it without it

 

Llc ftw!

 

Doesn't an LLC pay more taxes than a corporation?

 

technically yes, because all "income" is passed on to the owner(s) who have to pay "self employment income tax". An "employee" of an S-corp only pays employment tax on his "salary", not the entire income amount generated, and the rest of the profit is distributed through "shares" like stocks which is subject to regular taxes of course, but not "employment tax". The salary has to be reasonable otherwise the IRS will treat the distributions as income (you can't give yourself a salary of $1 and take everything in distribution, unless the corporation only makes $50 or loses money every year). A disadvantage to an S corp is the paperwork...because there's a "salary", the corporation has to do payroll and pay taxes for its "employees" (e.g. social security tax) regularly, while in an LLC the owner(s) have to pay their own taxes at the end of the year. An S corp also has to follow accounting rules and procedures just like any other corporation, so it's tons more paperwork.

The reason I started as sole proprietor is that I didn't have much if any assets before this building (my CL-S was the most expensive thing I owned besides my 401k, which to my knowledge they can't go after anyway). Now that I have a home, a nicer car, stocks, and a lot more savings and possessions, I'm open to more liability. But even this status quo doesn't compel me to form a corporation or LLC. The reason I plan to go LLC/corp is long term...when i refinance in 2 years, I will be "milking" it more for income than for equity building, and then use the equity that I already have in it as collateral for another building (and the increased income will contribute more to the new mortgage). And depending on how that does in 5-10 years and the equity situation I try to get more income generating real estate. And 5-10 years from now I will (hopefully) have even more assets to worry about and probably a family by then, so liability would be a big concern. Whether I go S or LLC will be decided based on how I want to develop or increase my holdings and how much paperwork I can handle.

This isn't technically my escape plan from my day job, just a side job. But if things go as planned, 5-10 years from now this will be generating more income for me than my day job with arguably a lot less work...I need to put in maybe 5hrs a week to manage the building, so 2 wouldn't hurt much, although any more and I'd consider a management company to take care of things.

 

if you do a 1032 exchange you wouldn't, as long as the other purchase is the same or more right? also is it just capital gains based on the difference from the selling price and the purchase price? how is rental income taxed?

 

also to the OP, why haven't you considered commercial real estate?

 

Rental income is taxed as income, but different depending on how the property is owned (sole proprietor, corporation, LLC).

As for capital gains calculation, I'm not exactly sure of the details, but rental/investment property is different from non-investment property because you have to subtract the depreciation from the basis and add on any improvements.

 

To the OP...With a condo comes HOA fees, a management board and headaches. These are all things you have little to no control over. They can all impact value. As mrdeeno stated, your personal time can be minimized by selecting the correct property and tennants.

Your money is made when you buy, don't overpay. A handy rule of thumb for small investors is GRM or Gross Rent Multipler. Simply annual gross rents times some factor ie - gross rents of $12,000 x 7 = $84,000 purchase price. The lower the factor the better if everything else is equal. Some research on your part will give you typical multiples in your area.

Real Estate is a long term investment accquired with leveraged funds and paid for with OPM. Do your homework and think before you jump in. If a property will at least break even, it might be worth a look imho.

 

Basis in Building = $100,000
FMV = $150,000
Mortgage = $80,000 or $120,000

For the $80,000 mortgage you recognize no gain, but for the $120,000 mortgage you recognize a $20,000 gain.

Same info above, your basis in the stock received would be

Basis = $100,000
+ Gain recognized ($0 or $20,000)
- Mortgage Amount ($80,000 or $120,000)
= $20,000 or $0

I'm taking a corporate tax class right now, and my professor said S-corps are only useful if you are just providing services. Otherwise he recommended partnerships or LLCs. I would highly suggest you sit down with a tax accountant to help plan your corp/llc/partnership.

 

As far as when you recognize a gain or not look up the General Utilities Doctrine for some info.

So let's say the corporation you formed has a basis of $100,000 in the building... then you depreciate that building down to $0 in 5 years. Surprisingly that building is now worth $1,000,000. If the corporation distributes that property to you, then it would recognize a $1,000,000 gain taxed at 35%, and your new basis would be $1,000,000 in the building.

Now if you had a partnership/llc, upon transferring of the building back to yourself, no gain would be recognized by the company or yourself. Your basis would be $0 in the building, since no taxable transaction has occurred yet. Then you could go and sell the building for $1,000,000 and have a capital gain taxed at 15%.

I know the example is a bit extreme, but you would have saved $200,000 by having a LLC/partnership formed.

 

Like I said before, I have homework to do before I decide which route to go, but I have a year to do homework before making any decisions.

 

I think you are confusing a C corporation vs. an S corporation. In your example, an S corporation would not be taxed a "corporate tax" on the $1MM gain, unlike a C corporation that would be taxed a "corporate tax". The S corporation does not recognize any gain because it has to pass everything on to the owner(s). The S corp would pay the "employee" their regular salary which would be taxed as income and employment regardless of the building sale, and the $1MM gain from the sale would be distributed and taxed as capital gains by the person receiving the distribution, the S corp can't be taxed anything (income, capital gains, or money from the sky falling into its lap) because it is REQUIRED to pass everything through to the owner(s).

 

Buying RE for the sake of buying RE is a great way to lose money. If you are not into RE, don't take a risk that you don't fully understand. We are going into what could be the buyers market of our lifetime, and it extends to everything, not just RE. Stocks are foolishly low and still dropping, no doubt in my mind you can pick a few companies and realize huge returns over the next 5-10 years, I am sure the same can be done with RE, but experience is key.

Larger multi-fam, like the 50 unit building that was suggested early is a nightmare for a novice. You need a property maintenance company, you will have nearly constant tenant turnover, and any expense can be astronomical to an individual who is not expecting it. That is not to say deals are not out there in this range, because they are, but is it the right move for an individual with a full time job who is extremely limited RE experience? In my opinion the answer to that is clearly no.

 

I know the difference between a c corp, s corp, llc, etc. The S corp would have to recognize the gain, BUT pass it to the shareholders that would be taxed at 15%.

A benefit of the s corp is the avoidance of self-employment tax of 15.3%. Since a s corp can have employees, they can pay salaries to employees. One thing that causes problems with this is what the IRS will define as a reasonable salary.

 

I agree...a 50 unit is way too big to handle unless it's going to be your full time job or you have a management company to take care of it.

A 4-unit that the OP originally inquired about I think is very doable for a novice and would be a good potential starting place, all depending on the condition of the building, cost, and how much support he has from any family or friends that have experience.

Personally, anything more than 4-units I consider it to be long term (ie keep it to generate income and only sell for major problems or profit). If you're just getting in to "test the waters", I would personally start with single family homes. That way if being a landlord isn't for you, selling a single family home is much easier than a multi-unit or mixed use building.

 

So why are you saying the $1MM gain would be taxed at 35% in your previous post?

 

I was referring to a C corp being formed, not a s corp.

 

I aree that smaller 4 unit would be better, but a single family is a bad idea for a rentaI if you have no tenants you are s.o.l. At least with a 2-4 unit it well at least in most cases carry itself with a vacancy.

 

I disagree for 3 reasons:

1. the cost of a single unit would likely be lower than a decent 4-unit, and initial investment would likely be lower since some banks don't have as stringent requirements for a single family home than they do for obvious investment properties such as a mult-unit (my bank required 25% down on my building, but only 10% down on the single family I'm in the process of buying for investment). Lower initial cost = lower risk. Further, banks consider experience when they give financing. They required I keep $10k in savings at their bank for the first 3 years since I did not own any property before and they knew I was inexperienced. That's a lot of dough to keep "locked up". This is likely not necessary in a single family home used for investment.

2. managing a single unit vs. a multi-unit is much easier. Any major problems affect only that 1 unit, while major problems in a multi-unit are more urgent when they affect all units. Maintenance on single family are easier since tenant will handle everything like mowing the lawn or shoveling snow. In a multi unit, the landlord is responsible for the landscaping and snow removal and such. For someone without much experience or time, a single family makes more sense from this perspective.

3. If being a landlord is not fun anymore, it is easier to unload a single family unit than a multi-unit. Single family homes can be sold to investors or someone just buying a home, and financing would be much easier for the buyer. A multi-family buyer is most likely buying for investment and therefore financing is more difficult for them and they will be looking at income/costs/condition/etc. more closely before buying, unlike someone buying a home who doesn't give a damn about "income".

Yes, if you don't have a tenant, you are SOL, but it at that point you can unload it easier. If you have a 4-unit and can't find tenants for 2, you are also SOL but also have a much more difficult time unloading it.

Basically what I'm saying is that a multi-unit is a bigger investment and a bigger commitment with bigger risks. A single family home is a smaller investment with less commitment and fewer risks. For someone inexperienced who may want to just get out if it's not for him, I am very reluctant to suggest the risk and commitment required for a multi-unit over a single unit investment property.

 

^ Must be different in PA, but "unloading" any unit right now in GA is hard... You make it sound like if you don't like what's going on you can just sell the house right away, but the market will dictate that.

 

You missed the point. No matter how hard or easy it is to "unload" a house, it is still much easier to unload a house than a multi-unit. Further, if things get that bad or if he really does decide it's not for him, then yes, he CAN just unload the house, even if it's for a loss. And that goes back to my previous post...a single family home is a smaller initial investment and if he takes a loss, it will be a much smaller loss than a multi-unit that would have required a larger initial investment.

And it's actually not that bad at my location. Real estate is down, but not catastrophic like other places you read about. But for people who have credit and cash (like me), it's actually a good time.