Home equity loan on rental house

[Russell Sherman]

I converted my former primary residence into a rental in 2022. Would I be able to take a home equity loan against this property to buy another property in Mexico? At some point I may want to sell the SFR? Is that permitted by the IRS? I purchased the SFR in the 1990's for $300k and estimate it's current value at about $1.5M. I would take around $300k in equity.

[Jeff Copeland]

There's a lot to unravel here:

1. Would you be able to take a home equity loan against a rental property?

A home equity line of credit (HELOC) is a long shot. The vast majority of banks don't like to do them on rental properties, and most are further tightening their belts as they gear up for a possible recession.

A cash out refinance, on the other hand, is very doable. Especially as the low LTV you are talking about, most lenders would have an appetite for that.

2. Can you use the proceeds to buy another property in Mexico?

Technically, you can use the cash you pull out to do anything you want. But you might not want to put "Buy a house in Mexico" on the line of your application that says "Purpose of Loan?" - It simply raises a lot of questions and potential red flags for lenders and underwriters. "Invest in more real estate" is also true, but sounds a lot safer to an underwriter!

3. Can you sell the SFR and is that permitted by the IRS?

I assume you mean the house here in the US that is the source of the equity? Yes, you can sell it any time you want, and the IRS has nothing to do with whether or not you can sell it. 

There are some major factors to consider, though. Such as:

When you sell it, all of the debt will have to be paid off. 

If it was your primary residence for 2 of the previous 5 years, you normally would not pay capital gains tax on the gain of $1.2M. This is huge. And it will dictate when you should sell, not whether you can sell. 

(Capital gains tax is 15% for most people, so there's a potential $180k +/- difference in your tax burden here. Definitely worth sitting down with a CPA and discussing!)