Buy worst house in good neighborhood for big profits
How serial investing can become a tax-free business
Friday, October 27, 2006
By Robert J. Bruss
Do you have any friends who sell their homes and move approximately every two years? I know several of those very smart folks. You may wonder why they change homes so often. No, they are not in the federal witness protection program. But they have a very profitable reason.
They are "serial home sellers." There is nothing illegal or immoral about that. In fact, it is extremely smart to sell your personal residence every two years or so, especially if there is no tax to pay on your resale profit.
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TAX LAW ENCOURAGES PROFITABLE TAX-FREE HOME SALES. Just in case you have no clue what this is all about, every homeowner needs to know that Internal Revenue Code 121 permits tax-free principal residence sales profits up to $250,000 (up to $500,000 for a married couple filing a joint tax return).
To qualify, the home seller(s) must own and occupy their principal residence at least 24 of the last 60 months before its sale. But IRC 121 can only be used every 24 months. If you want to maximize your tax-free sale profits, there are five easy steps:
1. Buy a sound, well-located house or condominium below market value needing cosmetic fix-up work.
2. Move in and make it your principal residence.
3. Make profitable improvements to the residence that cost less than the market value they add.
4. Profitably sell the house at a tax-free profit not exceeding $250,000 (up to $500,000 if husband and wife occupied the home 24 or more of the 60 months before sale and they file a joint tax return).
5. Repeat every 24 months to become known as a tax-free "serial home seller."
HOW TO MAKE PROFITABLE HOME IMPROVEMENTS. If creating tax-free profits, while enjoying your home is appealing, especially if you are a handyperson or in the construction field, serial home selling can be the perfect business opportunity. The only skill required is to recognize a house or condo with "the right things wrong."
Most older houses qualify, as virtually every house more than 10 years old needs paint inside and outside. Paint is the most profitable improvement homeowners can make. Spending $1,000 on painting often adds $5,000 to $10,000 in market value.
Other examples of homes with the "right things wrong" include the need for new light fixtures, fresh landscaping, new carpets and flooring, and overall cleaning and repairs. An especially profitable home improvement is adding a second bathroom to a one-bathroom house.
However, the "wrong things wrong" with a house are necessary but unprofitable work that doesn't add more market value than it costs. Unprofitable examples include a new roof, foundation repairs, new wiring, replacement of galvanized pipes with copper pipes, siding replacement, and window replacement.
Many home improvements are "nice to have," but they don't add more market value than their cost. Examples include bedroom and family-room additions, kitchen remodeling, and bathroom upgrades. Such work may make your home more desirable while you live there, but is unlikely to add more than the cost to the market value.
THE MAJOR DRAWBACK OF BEING A SERIAL HOME IMPROVER. If you think buying a run-down house, making profitable improvements while living in it, and selling it for up to $250,000 (or $500,000) tax-free profit sounds like fun, think again. It's hard work.
While you and your family are living in the house as it undergoes major renovation, that can be what TV's Dr. Phil calls "a life-changing experience." The disruption of not having a kitchen to cook in, or only one working bathroom for a large family, and the daily disruption of having strangers working in your home can't be fully described.
A few summers ago my neighbors went through such an experience. They wisely decided to take the kids to Europe so by the time they got back their remodeled home was almost finished. Yes, the marriage survived.
Because major home improvements can be traumatic, the smartest serial home sellers renovate their homes before moving in. Then they get to enjoy their fixed-up home for at least two years without the hassle and inconvenience of work in progress.
DON'T MAKE THESE COSTLY MISTAKES. Earning up to $250,000 tax-free (or $500,000 for a married couple) every two years excites most people. But there are some pitfalls to avoid:
1. Don't buy a house in excellent condition (it lacks fix-up profit potential). Instead, buy the worst house in a good neighborhood.
2. Avoid most condominiums and townhouses. The reason is no matter how nice you fix up your unit, its maximum resale market value will be held down by the recent sales prices of other units in the same complex. For example, if you fix up a condo penthouse but the other units in the building and the common areas are "ho-hum average," you won't earn much profit.
3. Stay away from "extreme makeover" houses, which need to be torn down (called a "scraper") or renovated by moving walls and rebuilding the interior. Profiting from such houses is extremely difficult.
4. No matter how much potential a fixer-upper house has, stay away if it is in a bad location, high-crime area, or the public-school quality is poor. These three criteria will hold down resale value no matter how well the house is upgraded.
WORK WITH A SAVVY BUYER'S AGENT TO FIND FIXER-UPPERS. Buyers of fixer-upper houses have a major advantage. Most other home buyers don't want these fix-up houses. They prefer to buy a house, turn the key in the door, and move in. That's the way to profitably sell your house.
A sharp buyer's agent will alert you when a fixer-upper house with "the right things wrong" comes on the market, whether it be in the local MLS (multiple listing service) or a "for sale by owner" FSBO. In the current "buyer's market" in most cities, there is little demand for these run-down houses offering profit potential.
Additional sources of profitable home purchases, which most buyer's agents don't follow, include foreclosures, probate and bankruptcy sales. Vacation or second homes can also be profitable, but they have special risks such as fickle buyer demand, which is often seasonal and volatile.
HOW TO PAY FOR THE IMPROVEMENTS. Fortunately, most "right things wrong" fix-up houses don't require costly improvements. To pay for the improvements, because the house will become your principal residence for at least 24 months, many major lenders now offer combination mortgages to pay for both the purchase and the improvements.
The lender's appraiser will evaluate both the home's current "as is" market value and the upgraded market value after the improvements are completed. The lender pays out the improvement portion of the loan as the work is completed.
Another finance method is to buy the house with mortgage financing and then obtain a home equity credit line secured by a second mortgage to pay for the improvements.
However, this method is difficult if the home buyer doesn't have much initial equity. More details are in my special report, "How to Earn Up to $250,000 (or $500,000) Tax-Free Profits Every 24 Months Buying and Selling Houses," available for $5 from Robert Bruss, 251 Park Road, Burlingame, CA 94010 or by credit card at 1-800-736-1736 or instant Internet delivery at www.BobBruss.com.
(For more information on Bob Bruss publications, visit his
Real Estate Center).
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Copyright 2006 Inman News