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Once upon a time, the BRRRR Method was the end-all-be-all way of maximizing your real estate buying power. But now, a new and more effective addition has been made to this method: the introduction of the “A,” which stands for advertising. Now, using the BARRRR Method, you will be able to save even more money, and get yourself on the path to real estate success more quickly.
As a real estate investor, it is not important for you to know every acronym under the sun. For those of you in the Bigger Pockets community, you are most likely all too familiar with the BRRRR strategy. Those of you who are not familiar with Bigger Pockets may have never heard of the BRRRR acronym before, but you may be very familiar with the strategy behind it.
What does BRRRR stand for? Buy, Rehab, Rent, Refinance, Repeat.
Why is this a big deal for real estate investors and a good strategy for many properties? Because many investors want to hold onto rental properties long-term (as opposed to flipping every deal they think they can force substantial appreciation into) but are hindered by the reality that they can only put 20% down so many times before their cash runs out.
The goal is that after purchasing a property, rehabbing it to force a large amount of appreciation into it, and then holding onto it as a rental property for anywhere from 6 to 18 months (for seasoning purposes) can often times result in a financial lender honoring a new appraisal on the property, after rehab and seasoning, and giving a loan to the investor based on that updated appraisal.
What does this BRRRR strategy accomplish for many investors? If the numbers work out, the refinanced funds they received from the lender are very close to (hopefully even greater than) the total funds they put into the investment property. Now they might own a property with a 75% LTV in which they are experiencing $0 in net out-of-pocket costs.
The “Repeat” part of the acronym comes into play since investors who successfully implement the BRRRR strategy can do it over and over again, since they aren’t actually losing all their cash reserves to down payments in the end.
So what is BARRRR? Ben Always Reads Red Rink Rampages.
No, it’s just BRRRR with an “A”. The “A” stands for ADVERTISE.
You might be thinking, “Duh, of course you need to have rental property advertising in order for possible tenants to know it is available. It’s implied in the “Rent” part of the BRRRR acronym.”
That is mostly true. The general purpose of the BRRRR strategy is for financing purposes so that the investor can get many more deals if desired. What we have found actually happens, unfortunately, is that many investors mess up the “Rent” part of the method and end up paying a lot more in taxes in the current year than they need to. Now we just got to the main point of this article!
Timing Your Advertisement
When rehabbing an investment property that you are going to hold onto as a rental (as opposed to flipping):
DON’T – Complete 100% of the rehab work, then advertise it for rent and get a tenant.
DO – Complete a portion of the rehab work, then advertise it for rent, then complete the rest of the rehab work, and get a tenant in there.
What different does it make if the same rehab work gets completed? It can make a big difference.
When a rental property is placed in service, expenses are now either categorized as operating expenses or capitalized and depreciated. There are many expenses that happen during a rehab that, if performed while the property was being rented out, would simply be expensed as repairs, cleaning and maintenance, or some cosmetic category.
However, all expenses incurred BEFORE the property is placed in service, no matter what the expense is, NEEDS to be included in the cost basis of the property, capitalized and depreciated, which takes anywhere from 5 years to 27.5 years (for residential rental property) to recognize those deductions on the tax return. Naturally, we almost always want to deduct as much as possible in the current year and avoid capitalizing expenses as much as we can.
So the next question is “What exactly does ‘ready and available for rent’ mean?” The “ready” is fairly basic: as long as a property is habitable (i.e. walls, doors, windows and a floor)and you could qualify for a certificate of occupancy in your locality, it is essentially ready for rent (there are some caveats here; be sure to understand building codes for your specific rental and location).
The date you determine the property is “ready” is a date you need to be able to justify to the IRS or state if your “placed in service” date is ever questioned or challenged by them.
The property is not “available for rent”, however, until it is actually advertised.
The IRS has provided multiple examples in which the placed in service date is the date the property was advertised (all the rehab work was completed prior to advertising in those examples). The IRS didn’t provide us with an example of a placed in service date in which some of the rehab work is completed before the date advertised and the remainder of the rehab work is competed afterwards. So we are left to interpret the rules and make decisions from there.
The IRS did not say that every item on your agenda for a rental property needs to be completed before it can be “placed in service”.
So we are left with the conclusion that it needs to be “ready for rent”, which is a particular date that you as the investor determine based off of how habitable the property is, and “available for rent”, which is simply advertising the rental property according to the IRS.
You should be able to provide proof of rental property advertising and should keep good documentation of your advertisements in case you need to furnish proof. You wouldn’t want to be forced to capitalize everything because the IRS disqualifies your advertisement date and then miss out on valuable current year deductions.
What You Should Do
Investors who are rehabbing a property that is going to be rented out should advertise their property for rent at some point before all the rehab work is completed – as early as possible.
It may mean that you advertise the property for rent the day you take title to it. It may mean you advertise the property for rent as soon as the largest, and more fixed, rehab projects are completed, such as electrical/plumbing overhauls, drywall, installing tile/hardwood flooring, and replacing the roof or siding on the house.
The point is that many expenses after the habitable “ready to rent” date would normally be treated as an operating expense for the rental property and deducted in full in the current year.
Example: Kangaroo Kevin purchases a single family home and has a rehab scope of $20,000. He determines that $10,000 of those expenses need to happen before it could be justified that the property is “ready to rent” or habitable. He plans his rehab so that those projects are completed first, followed by renting the property, and then completing the other $10,000 worth of rehab projects. The tax effect is that $10,000 is Improvements that are capitalized and depreciated over a period of 5-27.5 years, while $10,000 are potentially deducted in full on the current year Schedule E for that rental property (this amount would depend on whether or not each expense qualifies to be deducted in full under the de minimis rules). Nearly all investors would say that a $10,000 possible deduction in the current year is much better than spreading that deduction out over a period of up to 27.5 years. If Kangaroo Kevin decided to perform all the $20,000 worth of rehab work, then advertise it for rent because he completed everything on his list, he would be forced to capitalize everything and would not be able to deduct any of those expenses as operating expenses.
Here’s where I need to enter a very BIG disclaimer – I am NOT saying that just because you advertise early on, you will be able to deduct ALL of your rehab expenses in the current year.
You have to satisfy the “ready to rent” rule in the eyes of the IRS. That date will be different for every property under the sun and depends on the work that needs to be completed in order for the property to be considered habitable. I am NOT encouraging investors to expense items that are required to be capitalized under the current tax laws.
We want to see people advertise their properties for rent earlier than later so that they are not hindered by that simple requirement when it comes to reporting valuable deductions on their tax return. Advertise earlier so that you have the flexibility to discuss a “ready to rent” date with your tax advisor in order to expense as much of your rehab work as possible. If you wait to advertise until everything is complete, you are forced to capitalize and depreciate EVERYTHING.
So there you have it, BARRRR. The “Advertise” is more to emphasize the importance of advertising early, instead of when you are ready to move the renter into the property, from a tax standpoint. You do want to save money on taxes, don’t you?
Personally, I do not actually want to see the BRRRR acronym switched to BARRRR. BRRRR was intended to be a helpful acronym for financing strategy purposes, not tax strategy purposes. One member from Bigger Pockets suggested we take it a step further and make it BARRRRF (“Fly” to your vacation destination with all those tax savings).
And I sure don’t want it to be changed to LABARSRWRER – Leads, Analyze, Buy, Advertise, Rehab, Screen, Rent, Wait, Refinance, Enjoy, Repeat…..that’s not even catchy. BRRRR will always be catchy.