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Real Life Planning Podcast Episode 48: What is a Live-In Flip Strategy

Real Estate Coaching

In Episode 48 of the Real Life Planning Podcast, Cynthia Meyer, CFA®, CFP®, ChFC®, breaks down the live-in flip strategy - a unique approach to real estate investing where homeowners renovate their primary residence and sell it for a profit after at least two years. She explains how this strategy can help investors maximize tax-free capital gains under Section 121, outlines financing options, and shares insights into the benefits and challenges of living in a renovation. This podcast is for educational purposes only.


"...if you are somebody that loves the work on home renovation projects, this could be a good fit for you.” - Cynthia Meyer


This week on Real Life Planning Podcast:

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What is a live-in flip, and how does it differ from a traditional flip? [00:01:20]

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How does the Section 121 capital gains tax exclusion work? [00:02:06]

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What are the pros and cons of a live-in renovation? [00:06:12]

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 How can you finance a live-in flip? [00:12:44]

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What are the key tax rules and eligibility requirements? [00:17:45]




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About the Real Life Planning Podcast

Hosts Cynthia Meyer and Vekevia Tillman-Jones explore practical steps for real estate investors to build financial freedom and make working for someone else optional.


Episode 48 Transcript


[00:00:00] What's a live in flip? Today on the Real Life Planning Podcast, episode number 48, you're going to be talking about buying a home, living in the property, and renovating it during that time period where you're living in it, and then selling it in a relatively short period of time; after the renovation is done.

[00:00:19] There are particular tax advantages to that and it's a not uncommon real estate strategy, especially for folks who are just getting started, who are really design and rehab oriented. I'm Cynthia Meyer, a real estate investor and real estate financial planner and I often hear clients ask me if they think it's a good idea to live in a property, renovate it, and then hopefully sell it for a profit after a relatively short period of time. Clients often call this a live in flip strategy, but it's not a flip. It's what's called the serial renovation to take advantage of an element of the tax code that's called Section 121, the capital gains tax exclusion for the sale of a primary home. Now, I'm not a CPA. So, of course, think of this as education, not as tax advice. Go talk to your CPA if you have questions about how this applies to your particular circumstances.

[00:01:20] Got the disclaimer stuff out of the way. Why isn't a live in renovation and a sale after some renovation period- why isn't that considered a flip? Um, that's generally because folks who do this are looking to take advantage of the pandemic of Section 21, which requires that you live in the home for at least 2 out of the past 5 years in order to qualify for a large capital gains tax exemption upon sale.

[00:01:47] So a flip by definition is a short holding period, typical holding periods for a flip. If they're for somebody who's a professional flipper is, you know, maybe 3 or 4 months, maybe 6 months max. So that would not qualify in this circumstance. It would not qualify for the majority of the exemption. So let's dive in.

[00:02:06] So Section 121 really can help save on taxes when you're selling a primary residence. It allows taxpayers to exclude up to a quarter of a $1,000,000 that's $250,000 in capital gains for single filers and $500,000, that's half a million dollars in capital gains for married filing jointly filers on the sale of a primary residence if you meet the ownership and use tests.

[00:02:38] So you have to have lived in the property and owned it as your primary residence for at least 2 out of the past 5 years and you have to have

used that during that same 2 of the past 5 years, as well. Now, there's certain exemptions to that. For example, if you're in the military or if there are health circumstances or other unforeseen circumstances, like the death of a spouse, for example, and we're not going to dive into that in too much detail here; that's why you should always see a tax advisor if you're looking to claim exemption.

[00:03:09] But think about it from a planning standpoint, this is a really powerful tool. If you are an investor that has renovated before or has the ability to do some of the work yourself, if you're design oriented, or maybe you work in construction or there's trades- building trades, this could be a really wonderful way to get started as a real estate investor and a way to provide additional capital to start your real estate investing journey by providing a value add project.

[00:03:42] So think about how this would work in general, right? So, the investor is buying a residence. They may use a low down payment loan to buy that residence, such as an FHA loan, for example, where you can get into the property with as little as 3 to 5 percent down, maybe doing it as a house hack.

[00:04:03] Buying a multifamily property where you live in one unit and you rent out the other ones and then you move from unit to unit as they become vacant and you renovate each unit while you're in it. That's another common strategy. And when the property is completely renovated, at least two years and a day from the day of the original purchase, you would then put it on the market and hope to sell it at a profit, meaning that those renovations have added value or equity to the property beyond the cost of those renovations, right? There will be a return on your investments of time and money and effort into the renovation process. So that's where people get the idea, oh, it's a flip. So even though it's not a super short time period, it is the idea that you're renovating a property with the idea of adding value, and you're going to try and recoup that value on a sale.

[00:04:59] So, in this case, if you've lived in the property for 2 out of the past 5 years, then you're hoping to claim a capital gains tax exclusion for the sale of a primary residence; quarter million per single filer and half a million dollars for married couple filing jointly.

[00:05:17] So this can be a pretty powerful tool, right?

[00:05:20] If you're good at renovating properties, if you know what will add value in your particular neighborhood, if you're good at identifying a property that needs love but doesn't have, a deep hole of structural problems, this could be something that might be interesting to explore and to start to cost out for yourselves.

[00:05:41] Some of the things to think about in a renovation, you know, a buy, renovate and sell project like this with the aim of claiming Section 21 after 2 years, there are pros and cons to living in a renovation and, and those clients that we have at Real Life Planning that have done this before as an investment strategy have reaped financial benefits from the strategy, but they also had some difficulties, right?

[00:06:12] So from a financial benefit, basically, you know, you're going to save on, you may save on rent or mortgage by buying a property that is less expensive. So you're going to get in there and add value to the property. So the actual purchase price of the property might be lower if you, again, if you meet the Section 21 requirements, then if you've added value to the property through the renovation after more than two years, you can claim that Section, sell the property and claim that Section 21 value capital gains tax exclusion which is powerful tax free income or profits on the transaction, assuming that they're, you know, added value in the property.

[00:06:55] Um, you're right on the job, right? So even if you have contractors working for you, you're not a general contractor yourself, but you're right there and you can supervise what's going on it's a lot easier to do it when it's happening right in front of your nose than if you have to travel across town or across the state or country to supervise renovation. And there'll be lots of opportunities to DIY small projects yourself to save money on labor and profit potential through the appreciation from the adding value during the renovation can be a significant. Many clients that we've had have added value to their properties by doing this type of strategy.

[00:07:36] Think about it. You're living in a construction zone for two years or more. That's a lot. There's that kind of environmental effects of living in a construction zone, right? There might be open areas in the house that are open, you know, to the outside, or there could be dust or depending on how old the property is where you might have to abate certain things like lead paint, or, you know, if the property was built in the 70s, maybe there's asbestos that you have to remediate or something like. So there might be periods of time where you might not be able to stay in house during the renovation. A lot of that can be mitigated by doing a good inspection up front and staying away from properties that require major work or remediation like that.

[00:08:23] There's always the potential in any construction project for having delays and unexpected costs. For those people that are getting into doing your renovation for the first time, I think this is the thing that surprises folks the most about a large renovation project. You're not the only project on your contractors books, and he or she is going to have to balance different projects from different clients at the same time, and their own finances, you know, when different

people pay them and so consequently, and you may things may get permitted or not permitted or inspected or not inspected on time. So, you should expect delays and contingencies.

[00:09:03] There will be things that don't go- no matter how many times you've done it. And then there's just the daily stress of living in a construction zone, right? So, for example, if you work from home, you might not be able to work from home. I can't imagine having meetings with clients, for example, which I often do on Zoom

[00:09:19] I can't imagine doing that if there were hammering downstairs or there was electricity going on and off. I think that would be pretty challenging. So you may have to work somewhere else if you work at home. And then it's just, you know, you just don't live in a finished place, right?

[00:09:34] So you don't have as many areas to hang out and relax. You may not have a kitchen for a while. Maybe the bathroom doesn't work and you have to go take a shower at the YMCA or I, I'm just exaggerating the possible effects of living in a renovation. But you're doing a major renovation that's gonna add a major value, and you're living in that construction zone for a long period of time.

[00:09:55] So, but does that sound like you? Now, if you're, you know, young and single, or you're a young couple, and, or your kids have left the nest and you like the idea of working on projects in the house in your spare time, this would be perfect for you. Probably not a good fit for you if you have, you know- it could be dangerous if you have young children, right? To live in a construction zone. So it's probably not going to be a good fit for you to live in a major renovation if you're in the child rearing phase of life or if you have to care for an elderly parent, or, or you you must work from home.

[00:10:34] There are some things that would lean against you doing that kind of a rehab project to try and do this renovation value add to qualify for Section 21.

[00:10:45] So the other thing is, is that if it's your first time doing this, you might not know if you're going to enjoy it, if it's going to drive you bananas, if it's really worth it.

[00:10:57] I'm thinking about a conversation that I had with a client last year who had done one renovation over a multiple year period and then bought a house and then sold it at a profit and then bought a house, um, that needed a little bit more love the second time around was hoping to really move. Some design concepts in the second go around, but the work was- turned out to be

kind of a sensory overload and halfway through the project, you know, was looking for ways to move out of the house and into a rental during the remainder of the project.

[00:11:33] Just, if somebody is going to do this, you want to not bite off more than you can chew and really think about some of those sensory issues, right? And think about whether or not you want to be, you want to be working on the house in your spare time.

[00:11:50] The other thing to think about, of course, as a financial planner, you think about the capital that you have. Do you have enough cash to fund contingencies in the project or access to borrowing in order to do that? It's a segue, I think, into thinking about how do people finance live in flip or, or a serial renovation project. Now, typically folks are going to get into the original property, just conventional or conforming loan. They may take a low down payment loan, like an FHA type loan, which would require a lower down payment. And then you would have to pay mortgage insurance for some certain period, or until you have at least 20 percent equity in the property. That's the typical way that somebody buys the house, unless it's such a fixer upper that it won't qualify for a traditional mortgage, and then you would have to go to a private lender, what's called a hard money lender.

[00:12:44] So typically somebody's buying the house with a regular mortgage. Now, renovating it on the other hand is a different story. So there are a couple of choices for renovation loans. The first is something called an FHA 203k loan that combines the purchase price and renovation costs up to a certain amount of money into one loan. You can do that for a low down payment.

[00:13:10] Generally, contractors aren't big fans of 203k loans. There's a lot of bureaucracy and compliance that goes into that and that might not give you the flexibility that you want to find the best contractors for your loan. If you're doing a renovation after you've lived in the property for a while, and there's already a little bit of equity, you could consider a home equity line of credit. So, that could be perhaps equity against another property that you own that allows you to finance the renovation. You could consider a securities line of credit. So, for example, if you have a large taxable brokerage account, you may be able to get just regular margin or a securities line of credit. Of course, you wouldn't want to borrow too much that that would be risky. Certainly time to discuss that with your financial planner. Assuming that you've got a good risk management strategy in place, that may be a good way to fund an innovation project. A personal loan just guaranteed by your signature is another option. Liquidating stocks or accessing, you know, cash savings is always an option, of course.

[00:14:14] And then private or what's called hard money loans are short term financing with quicker approval. We did a video podcast just a few weeks ago about hard money loans, so we'll reference that in the show notes. Those are generally a little bit higher fees than traditional forms of blending, but can, the time to close can be a little faster.

[00:14:36] So, thinking through, again, if you're looking to buy or renovate, and then sell, thinking through and costing out project in all phases, right? Perhaps it may be something that has to happen room by room or system by system. The good thing about having at least a 2 year holding period is that you can make some time to work on parts of the project throughout that 2 year period.

[00:15:05] So, just some other tips for financial success, if you will, is, you know, budget for contingencies. You should always expect unexpected costs when you're working on any type of construction project. And you may build in, for example, a 10 percent contingency, and you should still have, like, contingency, contingency because things sometimes happen. And of course, we've all watched enough renovation shows on HGTV to know that they often happen at the worst. You want to plan renovations strategically to minimize living disruptions.

[00:15:41] I think it goes without saying, but I really want to invite you to think, like, if you are somebody that loves the work on home renovation projects, this could be a good fit for you. Even if you are that person, you are not going to want to do this every weekend and every evening for two straight years. So think about planning out the rhythm or the pace of the project so that there's still time for doing other things in life in between big renovation pushes. Some people may want to bunch all the renovation together, finance it all at once, get it done. Maybe that takes 4 or 6 months, and then they enjoy living in the property for a year and a half or more until they plan to liquidate.

[00:16:27] Certainly your bookkeeping is going to be very important. All of the expenses that you make in terms of adding to the structure of the property just get added to the basis of the home, right?

[00:16:39] So, you know, your furniture, it can't be added to the basis, but almost everything else can. And of course, this is something to discuss with your real estate savvy tax advisor, you want to keep a good record of everything that you've done so that when you go to sell the home, your tax basis is appropriately reflected in terms of how much money that you've put into the property.

[00:17:01] And then working with professionals for the things that you are not trained to do. People should not be doing their own electric or plumbing unless

they are trained as an electrician or plumber. This is not something you should be DIYing, there's plenty of things that you can DIY to save costs but you'll probably end up hurting the project and costing yourself more if you're non professional trying to do something that requires professional training and a license to do.

[00:17:29] Of course, making sure that all of your contractors are licensed and insured; to make sure that you're not going to run across an insurance issue yourself by hiring unlicensed and uninsured contractors, or perhaps it won't be done appropriately.

[00:17:45] So, I want to dig in before we finish up here. I want to dig in a little bit about this idea of the 2 tests that you have to pass in order to qualify for the Section 121 capital gains tax exclusion for the sale of a primary residence. So let's say you finished your project. You found a great home. You renovated it. It looks gorgeous. You've lived in it for a while and you want to put your property on the market. Take your profits and move on to a new project or to a new home that doesn't need a lot of fixing up. So you have to have owned the home for at least two out of the past five years, immediately preceding the date of the sale. That's called ownership test. So interestingly, the two years does not need to be consecutive. It can be cumulative. As long as it falls within the five year window. For example, hearkening back to that, um, person that I was telling you about that started a renovation and then realized mid renovation that it was just too much to live in the middle of all that mess and then moved out into a rental.

[00:18:57] If that person eventually then moved back in to the property and did not put the property in the market until they had lived in it a total of two years, both the first period and the second period and those two years would have to be within that five year window, then they could still qualify for the Section 121 capital gains tax exclusion.

[00:19:19] Now, that means, for example, because I know we have a lot of real estate investors that are listening to this video podcast, if you have a rental property, used to be your primary residence, for example, you still may take partial capital gains tax exclusion on the sale of that residence as long as you have put it on the market before the end of that 5 year window in which you have lived in it for at least 2 years.

[00:19:46] Now, the ownership test is only one half of the equation. The other half is the use test. You have to have used your home as a primary residence for 2 of the past 5 years, right? So, can't have been a rental property 100 percent of the time, right?

[00:20:02] So, like, the ownership test, those 2 years do not have to be consecutive. They just have to be total within the 5 year window. The 2 years of ownership and use can overlap, right? So typically they're going to be the same and possibly the situations when they're not always. So if you don't meet the full 2 year requirements because of unforeseen circumstances, like, you had a job change or you had some health issues or appoint to the military or something like that, you may qualify for a partial exclusion, and that's, think of it, it's generally prorated.

[00:20:38] Again, good reason to use a tax preparer, professional tax preparer, CPA, or an EA, when you are facing these issues to make sure you get this right. Don't DIY it. Um, there's some special circumstances, if a spouse passes away, the surviving spouse generally can still qualify for the full half a million dollar exclusion if the sale occurs within two years of the the late spouse's death and the ownership and use tests are all met here.

[00:21:08] There are some extended deadlines for people in the military. We're not going to take that in as a special use case today, but just know that if you're in the military or the intelligence community, um, you may have that extended for a longer period of time.

[00:21:22] So both spouses, if you do not have to meet the ownership and use tests independently to qualify for the full half a million dollars capital gains exclusion. However, um, there's some things to think about here. So only one spouse has to meet the ownership test 2 out of the past 5 years but both the spouses must be married filing jointly in the year in which they are claiming it. Neither spouse can have claimed that exemption, but within two years prior to this sale. So this is something you can only claim every two years, right? So we're thinking about that after two years have passed using the exemption the last time.

[00:22:11] But both spouses have to have used the property. They have to have met the use test even if they didn't meet the ownership test. So we can think of a situation where, um, spouse A moves into spouse B's house. They file a joint tax return. They have lived there for the past two out of the five years, but the home was owned by spouse B originally. They have to be married filing jointly. So, again, we're just talking about tax education here, not talking about tax advice. That's something you want to see a professional tax preparer about.

[00:22:47] To sum up, It sounds very attractive, doesn't it? To think about the ability to buy a property, live in it, renovate it, and then eventually add value to that property by making it beautiful and then after two years, selling that property and possibly paying no property gains taxes or only capital gains taxes above that exemption, right? Half a million dollars for a married couple filing jointly and $250,000 for a single filer.

[00:23:20] Sounds like a pretty attractive idea, but practically speaking, renovation is not for everyone, particularly the kind of substantial renovation that would add substantial value that would make this type of strategy worth it, right? To move in, renovate, and then move out in a relatively short period of time. So it might not be for everybody but if it is for somebody like you that's a great time to think about. If it is, that's a great thing to explore with your financial planner, making sure that you and your spouse are both on board, the idea of this project and to make sure that you know both potential rewards and the risks of doing it. That's it for today. We'll see you next time on the Real Life Planning Podcast


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