How to know when to sell for earned equity

Question

A little over 4 years ago I purchased my first property: a 3-flat in Chicago for $305,000.  In Logan Square - now one of the hottest real estate areas in the city in terms of %increase in value and %increase in home sales YoY.

The idea was simple - rehab all of the units, live in one, rent others to friends, find property manager when friends leave, hold for retirement.  I estimate that I put about $80,000 of my own money into the building over the course of 3 years.  Everything has been replaced other than the roof and one refrigerator.

Fast forward to today, and I have a little over a $200,000 principle balance on the building, with 11 years left on the 15-yr mortgage.  And an estimated value between $650,000-700,000.

With the $900/mo gross income ballooning to a little over $2,600 when the mortgage is paid off, I planned on making that a good half of my retirement plan.  But this post by Ben got me thinking - which I believe is always his intended purpose. http://www.biggerpockets.com/renewsblog/2015/06/09...

At first read, it seemed ridiculous.  Of course buy and hold works.  It's working beautifully for me.  But the value of my cash flow to available equity doesn't appear to be as high as I could obtain by cashing out my supposed $400,000+ in equity and purchasing two larger buildings, thus generating more cash flow now than I was planning on getting after my mortgage is paid off in 11 years.  And using a 1031 exchange, I wouldn't have to pay taxes on the appreciation of the building.

And I forgot to mention that I now live in Portland, OR where I purchased a home with a spare lot that I will develop in the very near future.  I don't need to list all the benefits of liquidating in Chicago and bringing that Equity closer to home.

So, my question to the BP community - given that this is all new to me - is what am I missing?  I got lucky with my first purchase and don't want to get greedy.  But I also don't want to leave money on the table by not putting my money to work for me in the most efficient way possible.

I realize there are a lot of factors at play here, so ask away if you'd like additional information.

Thanks all,

Brian

Account Closed · Answer

I might be mistaken, but my understanding of the 1031 exchange (I just did one), is that if the relinquished property can be classified as personal residence (allowing for the residence exclusion), it would not be allowed for a 1031 exchange.  On the other hand, if it's strictly classified as an investment property, it is eligible foe the 1031, but not eligible to pull out cash without paying capital gains (the acquired property must be higher in price than the relinquished property, and the total debt must be greater than the relinquished debt in order to avoid capital gains on the transaction).

Derek Walvoord · Answer

@Brian Jacobson

I think that even if it was a three flat, you can still take up to 250K for yourself, or 500K if you are married if it was your primary residence for 2 of the last 5 years.  So, you could theoretically take a pretty big chunk of cash out without penalty.  I have done that with some single family houses over the years.

David Stefanovic · Answer

Everyone's situation and goals are different, but I would personally cash in on the equity ($400k plus) and use it to buy a bigger investment property that would generate more cash flow. I have a similar situation with my duplex. I believe it's appreciated much in value where it may may make sense to sell it and use the equity to buy a bigger rental property that will generate more cash flow.

Kimberly T. · Answer

I have been contemplating something similar to you, only we're thinking of doing a Reverse 1031 (where you buy the replacement properties before selling the relinquished property - still all has to be done within 180 days, but then you're not rushed to buy something after your rental sells).  We own a triplex here in CA (as well as our house), and are strongly considering moving to CO in 3-6 years.  In CO, we could buy, say, a fourplex and a house for the amount we could sell our CA triplex for, and probably get a little better cash flow.  When we move to CO, we could then move into the house we bought, and later sell it if we wanted and keep all that profit tax free instead of tax deferred.  So, we'd be getting out of a landlord-unfriendly state, getting better cash flow, moving our asset to our planned destination, and turning some of that profit into tax free cash if we decide to sell it after living in it.  Boom!

This is the great cycle of wealth accumulation.  However, at some point, we all reach our limit.  We could keep doing it forever, but for us, we plan to stop the accumulation phase at some point so we can have more time for other interests in our lives.  Sure, it means we'll be sacrificing cash flow and wealth, but time has a value that should be considered as well.

Brian Jacobson · Answer

@Dave Foster

Interesting.  I had never considered that.  Although, it would only be 1/5 since I rented 1/2 of my unit to a friend, as well.  5 bedrooms in the building, so for all past tax preparations, my primary residence was 1/5 of the building.

And while the cash will likely be reinvested in real estate anyways, it takes some of the burden off having to pick a property within 45 days of closing, and close on that property within 180 days....at least I believe that's what the rules are.  It wouldn't need to be quite as substantial of an investment if I couldn't find the right one.

Dave Foster · Answer

@Brian Jacobson

You've got a double play here as well if I'm reading your post right. You bought this property and lived in 1/3rd of it and treated the rest as investment property fr 2 our of the last 5 year.  Now you have moved.

I think you could sell that property and do both a 1031 exchange and take out boot that would be washed out by your primary residence exclusion.  If you lived in 1/3 and your gain is 400K then you should be able to get $130K in cash tax free and 1031 the rest into a new asset or two.

That might give you something to think about