Planeta Books LLC

The two techniques that are the safest ways to make money in real estate are:

            1.) turn your residence into a rental instead of selling it

            2.) sell a house that you live in for 2 years, and pay no income tax on the sale.

Technique 1.) Turn Your Residence into a Rental Instead of Selling It

One way to obtain investment money to purchase fix-up houses is by refinancing a house that you already own. Refinancing a house means to take out a new loan on your rental property, or home, that replaces the existing loan.

When purchasing a fix-up investment property, you may decide not to sell your principal residence, but instead turn it into a rental property. In this case, the next house that you purchase and live in once again qualifies you for the lower owner-occupied loan rate. This approach also makes it easier to make repairs to the rental house because, having lived there, you know the tricks on how to fix the things that typically need repair.

A system that I like to use is to refinance my residence about 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:

        · refinance your residence

        · use the refinance money as a down payment to buy a new house

        · 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. 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.

When I did my first refinancing of a townhouse that I owned, I received a rate or 6.1%. The rate for my original loan was 7.5%. The original purchase price was $52,500 but the value had increased to $82,000 ten years later (Table 7.2). I had also paid off about $10,000 of the mortgage principal over the course of the ten years.

When refinancing, you should keep 20 percent of the value of the house in the house to avoid paying private mortgage insurance and to pay a lower interest rate. After refinancing the townhouse, my monthly mortgage payments went down from $535 per month to $518 per month. Normally, you pay 1 percent extra if you refinance as an investor instead of as an owner occupant. Although with good credit and by shopping around, its possible to have the 1 percent waived. You should time your moves so that you finance before you move out to take advantage of the extra 1 percent discount.

Timing Your Refinancing

Refinancing your mortgage loans is another aspect of real estate that will require you to develop some expertise and close attention to the details of the economy and interest rates. I have heard investors recommend refinancing every chance you get, regardless of interest rates, and to take out as much money as you can. That philosophy is a dangerous because you want to avoid raising your monthly payments beyond the point where you can afford to pay them.

While refinancing is common way for real estate investors to tap into the equity in their houses, you must be careful not to take out a large loan that increases your monthly payments beyond what you take in on rent. If you see that rents are going up in your area and you can increase rents enough to cover the monthly payments on a refinancing, then go ahead and refinance to take some of money out of a house. Ideally, that money is used to purchase more investment property. However, if your rents will not cover the refinancing payments, don’t put yourself in the awkward (and perilous) position of having to lose money every month.

Monitoring interest rates will also help you decide when to refinance. When interest rates are dropping, like they were in the early 2000’s, you were able to refinance a house, take money out, and lower your monthly payments. That was a real estate investor’s dream. As interest rates started rising again in 2005, it required that investors be more cautious in refinancing.

Technique 2.) 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 $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 you 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.

Capital gains above $250,000 for singles and $500,000 for couples are taxed at the applicable rate. For a complete description of how to use the exemption, see Internal Revenue Service Publication 523 Selling Your Home. What if you sell your house before meeting the two year requirement? If you qualify under one of the unforeseen events listed in the IRS publication, such as a job change, illness or an unusual hardship, you can still qualify for a prorated exclusion. Check Publication 523 for a complete list of unforeseen circumstances, at:

http://www.irs.gov/pub/irs-pdf/p523.pdf

What This Mean for Investors

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 a 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. Table 7.3 shows an example of federal tax savings under the tax exemption strategy

Here is an example to show how the exclusion works, illustrated in Table 8.3. You and your wife file jointly and you continuously buy and sell homes over the years, each time purchasing a more expensive home as a replacement. For the last 5 years you have owned a home that is now worth $600,000, with $300,000 worth of accumulated gain. If you were to sell your home now for $600,000, you would be subject to a capital gains tax on $300,000. The $300,000 is calculated by subtracting the $300,000 exclusion from the $600,000 accumulated profit. The amount of taxes saved would be $84,000.

Increase Cash Flow, Sell One House to Pay off Another

Cash flow is a key consideration in staying afloat financially for the real estate investor. One way to increase cash flow is to sell a house, utilizing the exclusion, and to use the money from that house to pay the mortgage off on another property that you own. It works best when you pay off a house that requires less money to pay it off. For example, if you sell your principal residence for $250,000, you might receive $150,000 after paying off the existing mortgage. With that money you could pay off the mortgage on another property that you own, with say $50,000, and use the remaining $100,000 as a down payment on one or two other fix-up properties. If you had been paying $700 per month for the mortgage on the other property, and receiving $800 in rent, you would now be able to receive the $800 in rent without having to pay the mortgage. This way you have increased your cash flow by $700 per month (not counting taxes and insurance).

Know When to Sell

I If you do sell your primary residence you should try to time it to maximize your profits. There are cycles in the economy and you can increase the amount you sell your house for if you are aware of the cycles. As John W. Schaub in Building Wealth One House at a Time wisely points out, “Buy when its hard to sell and sell when everyone wants to buy.” When housing prices are dropping and many people are trying to sell house, it is a buyers market and buyers have the upper hand in negotiating a price. When housing prices are rising and more people want to buy houses, and fewer houses are available, it is a sellers market and sellers have the advantage in price negotiations. When possible, sell during a sellers market.

Combining Techniques to Create Synergy

I have combined techniques 1 and technique 2 to get even more powerful results. Here is what I did. 1) I refinanced my primary residence to get down payment money for a new property. 2) I bought a fix-up property and moved into it. At this point, I had low-interest “primary residence” loans on both houses. 3) I lived in the new property while fixing it up and then sold it, taking advantage of the Taxpayer Relief Act exemption and paying no federal income tax. 4) I used the income from that sale as a down payment to buy a more expensive fix-up house.