Should I sell my rental property or let it ride?

Question

Hello Everyone,

Contemplating selling my investment property in the Rocklin/Roseville, California area.  The home was my primary residence prior, and if I sell the home next summer, I wouldn't have to pay capital gains taxes on the $200K appreciation (lived in home 2 out of last 5 years).  The home was a new build in 2019 with minimal maintenance and 30 year mortgage at 2.25%.  Currently, use a property management company and it requires minimal time on my end.  The property negative cash flows 400 dollars a month (not counting unexpected repairs), but I gain about $15K in equity each year paying down the mortgage.  I live in Upstate NY and own a primary residence there.  I have a high income as a healthcare professional, so the negative cash flow I can easily manage.  Would you sell it or let it ride?

After reviewing the forum, seems like the logical move is to sell the property.  I would make a big profit on the appreciation and avoid a large tax bill.  Seems like this property would not cash flow for a while and I would be speculating on future appreciation.  If I sell the house, I would like to use the money for real estate investments and would love to hear everyone's suggestions.

On the other hand, I could hold on to the property with the thought that I can handle the expenses of keeping it, while continuing to pay off considerable equity and gaining appreciation for each year I hold on to the property.

I would love to hear everyone's thoughts on what is the best option, as I have been having trouble making a decision given my limited knowledge and experience.  Thank you everyone!

-Greg

Dave Foster · Answer

@Greg Hammond If you decide the property is no longer worth holding on to and you decide to sell, in addition to the capital gains you want to consider depreciation recapture as well as any closing costs and commissions.

The good news is that if since it is being used for investment use, you could also qualify for a 1031 exchange and take advantage of the 121 exclusion. So if you have any additional gain left over after taking the 121 exclusion, including the depreciation recapture, you can shelter the rest in a 1031 exchange.

This method allows you to take some of the profit tax free and indefinitely defer the rest of tax, using it to purchase larger, nicer property/properties in areas with better cash flow potential.

Allan C. · Answer

@Greg Hammond not paying capital gains is enticing for sure, but you’re only saving $40k. I think your biggest asset is the 2.25% rate and the 2019 CA property tax basis.

For every $500k borrowed, you’re going to pay $20k/yr more on interest rate alone, plus higher property taxes. You’ll also pay transaction fees disposing the asset, likely in the $40k+ range.

I don’t think you have a clear-cut answer here, but you’ll need to rack up all the financial trade-offs to make an informed decision. My hunch is you won’t find a replacement investment in this market that is much better than what you have, especially if you are looking to redeploy $500k+ equity.

Trevor Finn · Answer

Hey @Greg Hammond,Given your situation, selling could be a strategic move. Since you’re eligible for the capital gains exclusion, selling now would let you cash in on the $200K appreciation tax-free, avoid ongoing negative cash flow, and put the profits to work in cash-flowing investments closer to you. This would reduce risk and speculation on future appreciation.

However, if you’re comfortable with the expenses and prefer to hold, you’d continue building equity, but it may take a while for cash flow to improve. Ultimately, it depends on whether you want to lock in gains now or play the long game. Would love to know what you decide to do! Keep me posted and good luck!

Adam Bartomeo · Answer

With the removal of the capital gains tax it seems like a "no brainer"!

The goal of real estate is to have the big FOUR - cash flow, equity, appreciation, and tax benefits. Every property should have these! Sell the property, buy 2 cash flowing properties that also appreciate.

Alecia Loveless · Answer

@Greg Hammond I agree with what @Theresa Harris says.

However the one thing I hear repeatedly is that long term investors say over and over “I never should have sold my early properties”.

It’s true you will net profits and can then reinvest them into something that cash flows better if you want to.

I’d look into historic appreciation data for the area before making a decision.

It is my understanding that many California markets make sense from the standpoint of future appreciation as opposed to immediate cash flow.

In my New England market I’ve been able to source some amounts of cash flow but my appreciation has been phenomenal and the projections for future appreciation keep me from selling to attempt to find better cash flow.

Only you can determine which makes the most sense to you.

Theresa Harris · Answer

Figure out what you save on cap gain taxes on $200K.  You are paying the tenants about $5K a year to live there (plus repairs).  They may be paying down your mortgage, but if you sold that house and bought a rental in a good area that cash flows...you'd come out further ahead.   I'd sell it and use that money and your high income to buy a place that will make you money, not cost you money.  It will take a long time to get anything close to what you'd save on taxes selling it before your primary residence exemption is up.