Buy or Sell In light of Capital Gains Tax?

Question

Bought a home for $170,000 in 2010.  We spent $94,780 in capital improvements/renovations before moving out in 2020.  We have been renting the house for the last three years ($27,240.00 annually in rental receipts).  We owe $87K on the mortgage.

Because it was our primary residence, we have until July, 2024 to sell without paying capital gains.  We spoke with a realtor who anticipates a sales price between $475K-$499k.

We can't decide if we should sell and pocket about $377,000 free of capital gains tax or continue renting with cash flow of about $9,500 annually after expenses.  Also, we know we need to purchase a generator at about $10K if we keep the home.

I appreciate any insight.  Thanks!

Michele Satterlund · Answer

Thanks Taylor.  Yes, 1031 exchange options are in my back pocket (no pun intended).  But my immediate decision (because I need to give the tenant's notice if I'm selling) is whether to sell before capital gains kicks in or keep renting.  We already own other rental properties and it's not high on our list in the immediate near future to acquire more (we are looking at building ADUs on property we already own), so don't see us doing an exchange.  Maybe, closer to retirement, we could move back into the property for two years to avoid capital gains.

David M. · Answer

@Michele Satterlund

Definitely sell and take the gains tax free!

If you 1031, that only defers the tax liability --- mainly until you die...  If you ever want to "get out," you'll have to pay the tax.

Better to take the gain tax free and look for your next investment, whatever that may be.  In the meantime, you can have your cash making 5% in these times.  Its really not that bad.  So, 95% of $450k is ~$427k --- roughly, conservatively figuring out your net proceeds.  5% of that is over $21k.  Even sitting in cash you make much more than $9.5k annually, and you have really no liabilities.  If you put your funds in a muni market fund, you can get it equivalently tax free and keep your tax structure low.

Also, the "buy and hold" strategy really does include "selling."  At times, its IS wise to sell

I'd be happy to chat if you'd like.

David M. · Answer

@Bill Brandt

Good point about the gains.  I didn't even bother to look over her numbers.  I lost also lost track of the mortgage so the proceeds would be even less.

Your ROE depiction clearly shows how this is a not a good rental.

Marci Stein · Answer

I think the answer has a lot to do with what you might do with the money if you sell . $377 k free of taxes is no joke! I am heavily leaning in that direction

Valerie Kinkead · Answer

According to IRS publication 523 https://www.irs.gov/publications/p523#en_US_2022_publink1000...

You could still take a partial exclusion to capital gains even if it has been more than 3 year since you moved out. So if you lived in the home for 12 months of the last 5 years, you would divide 12 months by 24 months, which gives you 50%. Multiply that by $250k per spouse. You used the term "we" in your original post, so I assume you're married. So each spouse can exclude $125k in this example. Your numbers will be different depending on how long you lived in the home from the date 5 years preceding the date of the sale of the home. So yes, you could still take an exclusion from capital gains, but you want to start planning now for the sale if you want to use this option.

Here is the worksheet from the IRS publication:

B) Complete this section only if you have determined that you aren’t eligible for the maximum exclusion but are eligible for a partial exclusion. If you are eligible for a partial exclusion, use this section to determine your exclusion limit.

Step 1

Determine the shortest of the following 3 periods:

1. Your time of residence in the home during the 5-year period leading up to the sale

_____

2. Your time of ownership of the home leading up to the sale

_____

3. The time that has elapsed between the sale and the date you last sold a home for which you took the exclusion, if applicable

_____

Step 2

Take the smallest period from Step 1 (you may use days or months) and divide that number by 730 (if using days) or 24 (if using months)

_____

Step 3

Multiply the result from Step 2 by $250,000. Stop here if not married filing jointly

_____

Step 4

Repeat Steps 1–3 for your spouse and add the two results

_____

C) Your exclusion limit is $___________. Unless you have taxable gain from business or rental use (see Business or Rental Use of Home), only gain in excess of this amount is taxable.

Michele Satterlund · Answer

Thank you.  I appreciate your comment.

Alex Olson · Answer

@Michele Satterlund If you don't like it, sell it and 1031 exchange. That is what it comes donw to. Then on your exchange find a property that improves your lift - cash flow, fewer heads aches, location, closer to home, further away...whatever you want. You will need to decide this.

Andrew W. · Answer

Depends on what your objectives are.  Personally, I would take the tax free now route.  I'd then utilize the $377K for other investments.  If you were looking to maintain some passive income but also wanted to use some capital to expand your real estate portfolio, you could do a cash out refinance, and use the proceeds to for other investments.  Eventually when you are ready to sell, you would have a capital gain.  However, you could do a 1031 exchange, you could invest the capital gains in real estate located in a qualified opportunity zone, deferring the tax and reducing the rate significantly over time.   Or you could die.... not to be morbid but if you were to hold the property until your death, your heirs would inherit the property and receive a step-up in basis.  So, in the end, that $377k you and your wife made, might never be taxed.

Dave Foster · Answer

@Michele Satterlund, Never fear.  All that has happened is your decision (and it was a good one either way) has been made for you.  Hold that property until you find something better.  Or it is time to sell.  then 1031 and the tax will be deferred indefinitely.

Buy or Sell In light of Capital Gains Tax?

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