If you want to make money buying, fixing and selling homes and know which properties to avoid — such as houses in excellent condition, houses needing major repair work (called scrapers or tear-downs), townhouses and condominiums — there are a few profitable types of principal residences where you can earn up to $250,000 (or $500,000) tax-free every 24 months.
The generally accepted definition of a potentially profitable fixer-upper house is a sound, well-located residence that can be bought for at least 25 percent below recent sales prices of comparable nearby homes in excellent condition. In other words, the profitable fixer houses need just cosmetic fix-up, which will add market value.
Of course, not all cosmetic improvements will meet this criterion. To illustrate, I’ve bought many fixer-upper houses that needed new roofs. A new roof doesn’t add market value, but it is obviously essential if the old roof is worn and leaking or about to leak.
LOCATION. In addition to being a basically sound house in need of profitable cosmetic fix-up work, the residence should be located in a decent neighborhood, particularly one that is not a “war zone” slum or a high-crime neighborhood. You will be living in this home, so the area should be one where you feel safe and won’t mind living.
The most profitable fixer-upper houses I’ve owned are in what I call working-class neighborhoods. Although it’s possible to increase the market value of expensive, luxury homes by making profitable improvements, my experience has been that the best profit opportunities are in middle-class neighborhoods or in areas that are definitely improving. When you’re ready to sell in a few years and claim your tax-free profits up to $250,000 (or $500,000), the buyer demand will usually be best in affordable middle-class neighborhoods.
GOOD SCHOOLS. Even if you don’t have school-age children, your future buyers probably will have children, so be sure to investigate the school quality. Profitable fixer-upper homes don’t have to be in top-quality school districts, but it sure helps unless there are compensating factors. To illustrate, where I live in California the public schools are ranked 1 to 10, with 10 being the best. Unfortunately, many public schools in Oakland, Los Angeles and San Francisco rank very low. But several of those neighborhoods have other compensating factors, such as high populations without children. Or, if you want to raise your children in a city with bad schools, plan on sending them to private schools for a quality education.
LOW CRIME RATES. No matter how nice a house is, if it is in a high-crime area the market value will be held down. You probably won’t want to live there so don’t waste time even looking at homes for sale in high-crime neighborhoods.
HOW TO AVOID POTENTIAL FIXER-UPPER PITFALLS. Although it sounds exciting to earn up to $250,000 (or more) tax-free every 24 months by fixing up houses, there is a potential disadvantage — you must live in the house as your primary residence for at least 24 of the 60 months before its sale. Since you have to live someplace, that doesn’t sound so bad.
However, unless you’ve lived in a house undergoing renovation, you don’t know how inconvenient that can be, especially if you have a spouse and children. To illustrate, I still recall when my neighbors remodeled their house. They wisely spent the summer in Europe while their house was being renovated, but most of us can’t afford to do that.
My suggestion is to get the major fix-up work completed before moving in. It’s much easier for painters, carpet installers and other workers to get their jobs completed in a vacant house. Although it might take a month or two for completion of cosmetic fix-up work, it’s best to get this work completed before you begin your 24-month occupancy period. Then you will be able to enjoy your freshly upgraded house. Of course, outside work such as new landscaping and exterior painting can be completed while you’re living in the house.