Should I sell or rent out my current home?

[Rich Pritzker]

Folks, Newbie here - so please be a bit soft on me...:-)

I own a home (#1) in the Nor-Cal South Bay-Area - which I bought a few years ago, for a little under $800k. Current mtg is $1300. Property tax is ~$900/mo. Add Home Warranty, Insurance, Gardener - to total upto $2400/month. Expected Rent is approx $3800-$4000 / month. So Cash-flow wise, I'm sitting ok if I only look at this property. Also, current Valuation of the house is approx. $1.4M.

Now- here's the complication - We just bought a bigger house #2 (our new primary residence) - for approx. $2.5M - with 20% down. The mortgage amt on this one, is approx. $2M. We know that mortgage interest is only deductible for upto $1M loans - so the interest on my second Million on this mortgage - is costing me post-tax $.

Annual household Income is approx $320k.

Both schools are in top school-districts (Elem/Middle/High are all rated 10/10).

I'm a bit nervous about holding house#1. I bought #2 at a high. Should I sell #1 when the market is up, too? It's a sellers market in the South Bay currently - but not sure how sustainable it is? How long it will continue...

If you were in my shoes - what would you do? Hold on to and rent house #1? or Sell it and pocket the $500k Cap gains and move on?

Thanks in advance!

-R