A serial homeowner can make a financial killing

By Jay MacDonald • Bankrate.com

 

Dan Shiner is thinking of becoming a serial killer. 
No, not the grisly made-for-TV variety. Shiner is toying with the idea of living serially in his rental properties for the two years required by the Internal Revenue Service to avoid capital gains tax, then making a tax-free killing when he sells them.

 

If he does it right, in as little as four years, he and his wife could legally walk away from two of their Mill Valley, Calif., properties with a cool $1 million profit -- absolutely tax-free.

 

Thanks to the 1997 Taxpayer Relief Act, single homeowners can exclude from capital gains tax up to $250,000 of the profit from selling their principal residence; couples filing jointly can exclude up to $500,000. Exceed those thresholds, and the IRS will tax the excess up to 15 percent.

 

There are a couple of restrictions. You must have used the property as your primary residence and lived there for an aggregate of at least two of the five years prior to the sale, and you can only take such exclusions once in any two-year period.

 

For most sellers, those requirements beat the prior law.

 

Home sale profits, then and now

When the law was changed, homeowners welcomed the rare good news from the IRS. The tax code previously allowed some home-seller breaks, but they weren't nearly as generous.

 

Under the old law, Shiner would have had to roll his gain into an equal or more expensive property, and that would have only deferred his tax to a later year.

 

"Actually, my wife and I are looking to downsize in a few years because we have three kids, one in college, one who starts college next year and one who is 10," he says. "We have a five-bedroom house, which doesn't make sense, so we are thinking of buying something smaller."

 

The previous over-55, once-in-a-lifetime exemption of $125,000 wouldn't have helped the Shiners much either. The home they bought 20 years ago for $157,000 is worth in the neighborhood of $800,000 today.

 

Now they face the attractive prospect of becoming millionaires before their nest is empty. Their two rental properties are paid off; their home will be shortly.

 

"We still haven't decided what we're going to do," Shiner admits. "Theoretically, we could move into one of our rentals for a couple of years, sell our primary residence which we would have lived in three and four years ago, keep the half-million from that, then sell the rental property and keep the half-million from that and come up with $1 million clean and be completely within the law. There are a lot of options for us right now."

 

It's a nice "problem" to have. And it's one that may become widespread as soon as baby boomers with rapidly emptying nests consider becoming serial killers themselves.

 

 

Anatomy of a serial killer

"Most people haven't figured this out; they haven't connected the dots," says Tom Lucier, real estate investor and author. "You have an opportunity for tax-free income, it provides you shelter, you don't have to worry about tenants so you eliminate property management and chances of vandalism, and you don't have to pay any taxes. If you buy right, it's risk-free."

 

Lucier says certain types of homeowners may make the best serial killers:

 

Singles

Married couples with preschool-age children

Childless couples

Empty nesters

Landlords with single-family rental houses

While not everyone is in the enviable position to reap a tax-free half-million on the sale of property, even smaller exclusions can pay big dividends, whether you're a retiree looking to supplement your income or a twenty-something scratching for seed money to invest for the future.

 

The key, however, is buying the right property. Lucier says serial killers in particular should adhere closely to his landlord maxim: Never buy a property in an area that you wouldn't want to live in yourself. After all, part of the plan is you will eventually live there, at least for two years and quite possibly more.

 

"Two years is an awfully short window," says Shiner. "There have been two-year slides [in housing prices] almost everywhere, even in

Marin

County

."

 

The longer you hold a property, the better your chance for a handsome, tax-free payoff. Lucier likes this scenario: Buy one rental property every year for 10 years. By that time, the oldest will have appreciated 40 percent or more. Then start moving into them in sequence, starting with the oldest or the one that has appreciated the most. Sell each after you have lived there two years, take the tax-free money and run -- or reinvest.

 

"You can do this forever. It's an excellent deal," he says.

 

Excellent, but not foolproof. You have to be sufficiently savvy to find good, self-supporting rentals, have the wherewithal to make mortgage payments when vacancies occur, and ideally be handy enough to do the maintenance and spiff-up work yourself before you sell.

 

"If you enjoy working on some of these places, a 'This Old House' kind of guy, then it makes perfectly good sense," says Kyle Krull, a certified tax planner in

Overland   Park

,

Kan.

"But if you're a person who would have absolutely no digits on their hands if they grabbed a power tool, you probably want to think about it."

 

Do try this at home

Not the landlord type? Become a serial killer in your own home.

 

"This strategy works just as well for homeowners. That's the beauty of it," says Lucier. "You could move, say, every five years. In five years, your appreciation could be 30, 40, 50 percent of value."

 

It's also a way to support yourself in your golden years by doing what you may have been dreaming about doing anyway: traveling the country. Thanks to the Internet, you can easily narrow down potential properties to buy, even in small towns. Downsize, stay light, meet new friends. Think of your serial homes as a cash cow that you milk a little more often.

 

"Most people are not going to realize a half-million gain on a house, but what if you made $50,000 to $70,000 tax-free? That's more than most people make at a full-time job," says Lucier.

 

His advice: "Buy some place people are going to want to move, not where they're trying to get out of." His best bets are

Florida

and parts of

Texas

(still affordable); worst bets include

Atlanta

(overbuilt),

Seattle

(overpriced) and most of

New England

(overtaxed).

 

Boomer boomerang?

You might even consider starting the kids off as serial killers.

 

Rather than forking over rent money for four-plus years for your college-bound son or daughter, you buy a good investment property near campus as the student's own private Animal House. You deed the house over to them in their sophomore year and continue to help them pay their note with the IRS annual gift exclusion, which currently is $11,000 a year per taxpayer, meaning mom and dad could give their student up to $22,000. Upon graduating, they have the choice to keep the house, rent it out or sell it and take the gain tax-free to pay for law school, med school, or to invest in their next "hit."

 

This works even better if you have two or more children planning to attend school in the same area, because it allows for greater appreciation.

 

Krull thinks it's a smart financial move: "I've had clients who buy a house in

Collegetown

,

U.S.A.

It's also a good way for an out-of-state family to establish residency for in-state tuition purposes."

 

Remember that advice about investing where people are moving? Guess where the baby boomers are headed? That's right. Back to their old college towns.

 

Krull thinks the perfect counter to the boomerang kids era would be boomerang parents choosing to kill off the family home and downsize right into the college rental their kids just destroyed.

 

"The boomers are going to want to be active, and there's a lot going on in a college town, from sports to arts to intellectual pursuits. A lot of baby boomers are going back to their old alma mater towns. They like the college life," Krull says.

 

"That's what we're seeing in

Lawrence

with the

University

of

Kansas

. There's a big housing boom with lots of retirees moving there. Sure, move the kids out. And their roommates. And that pet monkey they had!"