Previously, I wrote about the real estate investment strategy called "house hacking". You can learn more about it here. Today, I'd like to share another strategy with you that I like to call the "live-in fixer upper" strategy. This is a more common strategy than house hacking because, although it is hard and stressful, it is more realistic for most people's circumstances.
What is the "Live-In Fixer Upper" Strategy?
The strategy involves purchasing a fixer-upper as your next primary residence. You then live in the property for the next two years (minimum), all while fixing the property up, then you sell it, and repeat the process.
Why Does it Make Financial Sense?
The tax code says that if you live in a property for two out of the last five years you do not have to pay taxes on the gains from appreciation and sweat equity that you have received. For example, let's say you purchased a property for $200,000 that was a fixer-upper with great potential. For the next two years, you work on this property on the weekends to fix it up and make it look amazing. After two years the property has appreciated because the market has appreciated 3% per year. Additionally, your sweat equity has increased the value of the property another 20%. now your property is worth over $250,000 and you owe less than $200,000. That $50,000 of profit or "capital gain" for the last two years has absolutely no tax.
What are the Risks?
The risks with this strategy have to do with your buying choice and the condition of the market. You must buy the right property, in the right area, for the right deal, with the right potential for growth and improvement. You need a good real estate agent who knows the market to help you on this one. You must also have the skill necessary to put in valuable sweat equity that will increase the property's value. And also, the market must continue to appreciate in those few years. However, let's say the market goes down for those two years. Then you have several options. You could hold on to the property until the market rebounds and then sell. Or you could move out of the property and live in another fixer-upper for the next couple years and then sell the first one. My understanding is that you would still have the benefits of no capital gains tax on your increase from the first property as long as you lived in the property two out of the last 5 years from the time you sell.
Why Don't More People Do It?
It's not easy to find a good fixer-upper deal in a hot real estate market. And once you have the deal, it's not easy to spend your nights and weekends working on house projects. For those reasons, many people will not purchase a fixer-upper but look for a move-in ready home and purchase it at retail value.
Personally, I am following the fixer upper strategy now. We looked for a full year before finding the right fixer-upper property. We now are spending the next 2 to 5 years working on the property to make it amazing. At which time, as long as the market continues to appreciate, we will sell the property and repeat the process. If the market does not appreciate, we will continue to live in this property until it makes financial sense to sell. All the while, we're living in a beautiful home that we are fine to stay in for a long time if necessary and we're spending time together working on our projects.
I Can Help You Do This
I'm doing this strategy myself. I can help you do the same. If you are in Utah, Salt Lake or Wasatch Counties, let me help you find the right fixer upper.
I am not an accountant. All of these figures, recommendations, and stats should be verified with your accountant.