Should I stay or should I go?

Question

Thanks for reading my first post on Bigger Pockets. I need your advice.

In 2015 my wife and I sold our home in LA for a healthy profit and moved to SLC. I knew nothing about real estate, but listened to my CPA and decided to invest. With the money we made, we paid off half of our debt, purchased a fourplex to rent full time, purchased a duplex that we owner occupy and lastly did a full remodel on both units in the duplex.

So, now we have been living in our duplex for two years with half that time having the other unit occupied since we did the remodel. We are now thinking about selling our duplex since we would pay little capital gains in only having rented it for 12 of the 24 months.

It should be noted that my family and I love this duplex, there is definitely some emotional attachment here. It's an amazing layout, it's in a great neighborhood and the remodel really makes us feel at home.

So, the question is, do we stay living in this awesome place and just continue to save up for our next rental property in approximately five years, which would allow us to keep this rental in a great location? Or do we sell and take advantage of the increasing real estate here which also doubles with our remodel? Our broker ran a conservative, low number scenario for us and it looks like we could do almost the exact same thing we did back in 2015: pay off our remaining debt (so be debt free), purchase another full time rental, purchase another o/o duplex and have a little money leftover to remodel it.

My delay comes from hearing and reading things like: never sell a rental property if the purpose is to build a rental property portfolio, never sell that duplex, it's in the best area (one block from the University of Utah) and so on. Plus, the emotional attachment.

Thoughts?

Lauren Speidel · Answer

@Bernard Evans - @Clayton Mobley is absolutely correct, if you decide to do a 1031 Exchange with a portion of the proceeds, you will want to enlist the help of a Qualified Intermediary that has the expertise and experience to safely handle your transaction. Combining the 121 Exclusion and 1031 Exchange can be a powerful tax deferral strategy. When you complete a straight forward 100% tax deferred 1031 Exchange, one of the requirements (and there are a few) is that you trade equal or up in value from your net sales price. Since a portion of this property is being used as your primary residence, you of course won't need to replace the full net sales price. If you are contemplating this type of mixed transaction, you should speak to your CPA to determine how much of the net sales price is considered the investment portion that you need to replace.

Clayton Mobley · Answer

@Bernard Evans I will second @Thomas S. and @Ana Garcia, the whole 'never sell a rental' refrain is not good advice. Of course, if you're looking to buy and hold and generate passive income, you don't want to sell a rental in the first year or two (barring emergency situations) but you've already bought, you've already held, so I wouldn't hold onto this cash cow just because other people think you have to keep everything you buy forever. A lot of success in REI comes from leapfrogging your investments into bigger and better investments.

However, Ana is also right on the money that this decision really comes down to your goals. How much do you owe on this property, how much cash flow is the other half producing? Is it enough to cover your mortgage payments and then some? Are you essentially living for free while collecting cash? If your goal is simplicity, comfort, and passive income, you might stay put and wait until you actually want to move. I'm not familiar with UT markets, but if those in-the-know feel appreciation will continue, and you're not hurting for income right now, an appreciation play that makes your life easier is fine, if those are your goals.

If your goal is to be debt-free as soon as possible, grow your portfolio as quickly as possible, and set yourself up for early retirement, then it may be time to leapfrog this property. Since it is a duplex and you occupy one side, the whole capital gains situation is a little tricky, but you wouldn't pay the max amount in any case. Since you have occupied your unit for two years, half (assuming both sides of the duplex are identical) of your gain would be tax-free (up to the $500k limit for married couples filing jointly) under Section 121. The other half of the gain is from investment, so you would have to pay taxes there. However, as Ana mentioned, you could execute a 1031 for that portion and leapfrog this asset into some tax-free income from the principal (Sec 121) and some tax-deferred reinvestment from the other half (Sec 1031). You can combine these two tax benefits pretty easily.

For example, assume:

Duplex value: $500k, divided evenly between two identical halves

Mortgage Balance: $200k, $100k attributed to each half

Total Equity: $500k - $200k = $300k, or $150k each half

Sec 121: Sell your half for $250k, pay off loan, take all gain tax-free

Sec 1031: Sell the investment half for $250k, roll value into replacement props and defer taxation

Here's a bit about mixed-use props and 1031 Exchanges (See Section 3): https://apiexchange.com/1031-exchange-primary-resi...

Douglas Larson · Answer

Hi Bernard.

I ran across this post from a few months ago. What did you decide to do?

There is always a cold, hard math formula that may indicate the right financial approach, but there is so much more to life than following the numbers or tax implications, especially if you are talking about your personal residence.

My first inclination would be to hold a good cashflow property and buy another home for yourself with the low mortgage rates we still have. Fall and winter can be a great time to buy and get a good deal. If you buy another Duplex or a "functional duplex" with a basement you can rent out, you can keep your expenses low and save up for more investing.

That said, If you love where you're living, go buy a rental on the west side with some heloc money on your current place and a new mortgage. West Valley, Taylorsville, Kearns - they all have some great opportunities for good cashflow. You just have to screen your tenant applicants well. I've got several rentals over there now and another under contract.

Above all, have fun out there!

Bernard Evans · Answer

Hey everyone, thank you for your replies. It is definitely helping me and getting me more informed. Here are the financial details that may help in your replies:

Purchased in September 2015 for $403,000

FHA loan, mortgage remainder $380,000

Remodeled both units $95,000

Mortgage $2,333/month includes taxes, insurance, pmi, P and I

Rental downstairs $1,250/month

Conservative take home guesstimate if we sell after fees, closing costs, commissions, etc $171,000

Hypothetically, I would use about 1/3 of that to pay off remaining debt and become debt free, a small chunk of that to do another FHA O/O duplex, a big chunk of that to do 25% down on a rental and the remaining money used to remodel the O/O duplex.

The other option is to keep this and live in it, continue to pay down debt (approx five years), then start saving for another rental property after I'm debt free (another approx 3 years). So, in 8 years I could purchase our "forever home"  and keep this duplex and rent out the top.

Hope this additional info helps.

Matt R. · Answer

Sounds like a quality location with quality future cash flow, low vacancies, rent appreciation like LA ( actually the passive income part for REI ) etc...and since passive wealth is created by holding quality locations longer haul/multiple cycles I am not sure I would bail that yet unless it was for even a better location.

Good luck!

Clayton Mobley · Answer

Lastly, if you do want to execute a 1031, you'll need a Qualified Intermediary before you get started. There are some specific rules and timelines you need to adhere to, and you can't touch a single cent of the proceeds of the sale or the 1031 is void. A good QI will have ample experience with mixed-use props (where part is investment and part is owner occupied), and there are a couple great pros here on BP.

It's all about your goals. The objective investor in me says ignore your feelings about this property and cash in now, use the 121/1031 combo to maximize tax-free gain and leverage yourself into a cash flow portfolio. But the actual human in me knows that that may be a big leap, and your current and long-term goals may not be the same as mine would be. I'd say your first step is to turn off the computer and have a serious convo with your partner about what you want to get out of your REI investments short and long-term. Everyone has opinions (some educated and some less so) but it sounds like you've done all the reading you need to, and now you have to just decide what's right for you.

The good news is, you're in a great situation and you'll likely end up ahead whichever way you go. If you want to accelerate your progress and set up long-term income streams, it's time to sell. If you're happy with your current pace, hang on and see where appreciation takes you.

Best of luck,

Clayton

Clayton Mobley · Answer

Now, half of your mortgage is attributed to the investment portion of the sale, BUT in order to execute a 1031 you don't have to carry over your debt. Contrary to what many people think, the actual requirements are that you carry over the total value of the sold property ($250k) AND that you carry over AT LEAST the same amount of equity ($250k value - $100k debt = $150k equity). HOWEVER, if you don't want to have a mortgage on the new property, you can use the sale to pay off the mortgage and then put in an equivalent amount of your own cash to compensate. So the $250k total value can be $150k equity + $100k debt (as in the current prop) OR $150k equity + $100k cash (or anything in between as long as it adds up to $250k). Basically, as long as you put at least the $150k equity and the total value of the new prop(s) is $250k or more, you're good. You can do more equity and less debt, but not less equity and more debt.

All that is to say that you have options. If you want to be entirely debt-free and own all your investments free and clear, you can pay off your loan with the sale, and put more of your gain toward the new investment.

Sec 121 Gain: $250k - $100k debt = $150k

Sec 1031: Sell for $250k, put $100k to pay off loan, use remaining $150k AND $100k of your cash to complete the exchange and defer all taxation.

You end up with: No debt, $50k net tax-free gain in your pocket (from your Sec 121 gain), $250k in tax-deferred replacement prop(s)

I personally don't typically recommend that investors go all-cash. For rentals, it dramatically increases your ROI to use leverage and then let your tenants basically buy you 75-80% of a property over time. But not everyone is comfortable with debt, so it's important to highlight the options.

If you want to use all cash, $250k could get you 2-3 good rentals in the South or Midwest, which would produce great rental income since you wouldn't have any loan payments. This is great if your goal is current income.

If you use leverage, however, you can parlay your $150k equity into a number of down payments and roll this one duplex into a nice little portfolio of rental properties. You'd end up with much more than $250k in total value and you'd need to be comfortable with/qualify for multiple loans, but $150k could easily put down 6-7 down payments on great B/B+ turnkey rentals (in Birmingham and likely other markets). The gain you net from the sale of your half of the duplex could be put toward your new home and/or held as a reserve. This strategy would be a more long-term play, of course, since you'd be holding props for 10-15 years while tenants pay down your loans. But, once you're ready to retire, you could have a nice portfolio of free and clear properties that do nothing but produce passive income. This is better if your goal is maximizing returns and you don't need to maximize your investment income right now, but you want to set yourself up to have a lot of investment income down the road.

Amanda McPherson · Answer

Congrats on your move. Sounds like a great investment. My advice is to stay and save. You have motivation since you like it, and I'm sure it's keeping your expenses low. It feels like home and that counts for a lot. It also sounds like it has great potential now and in the future for appreciation. I think the SLC will only keep getting better, but if you like where you live, it means a lot.

I'm also considering moving to SLC soon from CA, and will likely do a 1031 exchange from a rental SFH I have here. Would you mind telling me the name of your broker? I'd love to get connected to people and deals in the area. I'm interested in multi-family, syndicates etc.

Kristina Heimstaedt · Answer

If I were in your shoes I would talk to my lender about getting a HELOC now. I'd make sure I used it now for something and make sure that I was ready to max it out when the market has any sort of correction or hiccup. Personally, my goal is to always go against the grain and plan for having as much cash as possible when everything is on sale.

I take the attitude that when the market is cruising, I don't move, hold and prepare my lines of credit for when I want to really move. If you're happy being there and it works for you, stay. Just be prepared to not miss out in that next deal in 5 years by having a line of credit on your primary residence.

My main argument for this is that the one thing that you can't change are your property taxes. If you can keep those at the "on sale" price, I'd work my butt off to make that happen.

Sam Shueh · Answer

Hold for a longer time. Too much work and put into.

Should I stay or should I go?

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