When would it make sense to upgrade home?

Question

I have an existing home valued at around 800k with 45k left in the mortgage. We have been looking to buy a newer and bigger home for the last year but due to the tight inventory, could not find a home that has everything checked. Even if an odd home hit the market, the listing price is exorbitant and the mortgage rate at 7% does not help at all. With all said and done, we could not find a home in the 1.5 - 1.6M range. The monthly payment would be north of $10k, with taxes and insurance included.

Our idea is to rent out the existing home. The rent would partly cover the new home but I am not convinced on the ROI with the majority of the payment going out to the interest.

I want to hear from fellow BiggerPocketers if they recently upgraded their home. If so, how did you do it and are you happy with your decision? If you considered and backed out, I want to hear as well. When would it make sense to upgrade the home, assuming you can afford a 10k payment.

Bruce Woodruff · Answer

As a GC, I used to get jobs a lot where people would upgrade their home before selling in an attempt to make it more desirable (or so they thought). I often would be called back to redo what I had just done.

People (especially those with lots of $$) know exactly what they want in terms of material, brands and colors. Not so much on an average house, but in your price range you will not always get your investment back.

Just my .02.

Bill B. · Answer

Almost zero upgrades will make you money, the best hope to get 80-90% back. You do upgrades to enjoy them unless the thing you’re upgrading is unsafe or “severely” outdated. Then the dream would to get 110% back and pay 5-6% in commissions, netting 4% or less. And that’s the dream result.

The amount of equity has nothing to do with taxes owed. BUT.  Assuming at least  $500k is all gain. I don’t see how any financial advisor could say to do anything other than sell. You’re looking at at least 30% taxes with federal/state? Maybe 35-40%?  That’s at least $150k in extra taxes. How long do you think it will take to PROFIT $200k (so you can pay another $50k in taxes.) from renting the property out?

Also, don’t bother offering seller financing. The only person willing to pay 7% wouldn’t be worth the risk. And there’s no reason for you to do it for any less if you can get 5.5-6% from a guaranteed bank investment and/or you’re going to be paying 6-7% on your new mortgage. So you’d be lucky to break even.

Michael Smythe · Answer

Couple of thoughts:

1) If you sell existing home, you're most likely eligible for tax-free gain of $250k individual / $500k married. Tough to pass that up given the amount of equity you have.

2) If you decide to keep existing home, you might want to cashout refi on it and use those funds for downpayment on new purchase. Tough to deduct mortgage interest on primary home, but you can deduct on rental (Schedule E).

3) If you remodel existing home AFTER converting to rental, improvements probably tax deductible. Some will be repairs deductible immediately, others may be considered capital improvements and will need to be amortized.

Of course, verify all this with a tax professional.

Jake Andronico · Answer

@Joseph Henry

Regardless of what you decide, you're in a GREAT position.

On BP, you'll likely hear more about how to turn all of that equity into cash flow w/ rentals.

If you're house shopping for yourselves, and decide to sell, you should have the benefit of Section 121 in the tax code: https://www.irs.gov/pub/irs-drop/rr-14-02.pdf

As Michael said, $250K gain tax free as an individual and $500K if you're married (always check w/ a CPA).

One interesting option to consider would be to seller finance for someone looking to purchase your existing home.

That way, you become the bank, and earn interest each month off of the note.

Say you seller finance $600K for somebody, you could be earning roughly $3K per month in interest at 6%.

And you'd have some extra cash to purchase your new home (assuming they put 20% down, or approx. $160k)

Noah Laker · Answer

Hi Joseph, I'm a local broker and investor and property manager in Sac. I specialize in Airbnb / STR (100+ listings!).

There is data on this, actually. One of the highest ROI renovations you can do is a new kitchen. Other examples are exterior facade work and landscaping. These can be relatively cheap upgrades while increasing your potential sales price (or rental rate) significantly, even just psychologically by making your home so much more attractive.

Your line of thought makes sense, you'll just need to decide if you want to keep your current residence as a rental, or do a transfer into something else for potential tax savings (I'm not a CPA nor qualified to make that determination).

Happy to run through some scenarios with you any time :)

When would it make sense to upgrade home?

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