The Age Old Question...Sell or Hold?

Question

My house by is worth roughly $385,000 i owe $233,000 on the loan. I bought the house in March, 2015. So if i were to sell the property today then my capital gain would be roughly $152,000. I lived in this house as my primary residence for 18 months which makes me eligible for a pro-rated homestead exemption however, that might not matter - i will explain.

I have not worked at all this year and i expect to make less than $39,375 between now and the end of the calendar year, my long term capital gains tax rate is 0% for 2019 (see https://www.nerdwallet.com/blog/taxes/capital-gains-tax-rates/). So as far as I can assume the homestead exemption is moot here and takes a backseat to the fact that I have a net 0% capital gains tax status for 2019.

The question is, do i keep my property and take advantage of my capital gain tax status since i am unemployed, or hold onto. I have made a couple of compounded interest scenarios. Assumptions are that any other year i will be working, i fall into the 15% capital gains tax bracket a well as a 5% compounded interested increase YoY. (On average, my current home's value has increased on average 8% YoY from the time i purchased it until now.)

Scenario 1: Hold on for 5 years

Estimated 5 year value: $494,000

Estimated loan amount: $209,000

Estimated taxable gain: $42,750

Estimated net profit: $242,250

Scenario 2: Hold on for 20 years

Estimated 20 year value: $1,044,366

Estimated loan amount: $137,000

Estimated taxable gain: $136,050

Estimated net profit: $770,950

Obviously there are assumptions made here. Property value increase YoY, the Feds will not change the capital gains rates in consumers favor (not likely), etc.

I could of coarse do a 1031 exchange later on in the future, but as i'm sure you know, the tax penalties are only deferred and they catch up to  you the day you go to cash out eventually.

Seems like an obvious one. But still would rather have a collective opinion. What are your thoughts?

Bill B. · Answer

A few things you’re going to want to clear up...

Number one. I’ve never heard of getting a partial exemption for living in a home for 18 months, I’ve always heard it’s two years or you pay 100% of the capital gains. Can you point to a source for this idea of partial credit?

Number two.  I’m 90% sure your capital gain is going to get tacked on to your income so you’re going to be paying 15% capital gains tax

Number three: don’t forget about the depreciation recapture you’re going to owe at 25%

Joe Splitrock · Answer

I look at it this way. Taxes are your largest expense (that doesn't add value). If I was to bet, I would assume 20 years in the future that tax laws would be less beneficial to investors. So given the opportunity to take $130K tax free today versus potential of $700K taxed in 20 years, I like the $130K option.

If you can invest that $130K into an investment that gives you 10% growth each year, compounding, you will have over $700K in 18 years. I use 10% because it is pretty easily attainable with rental properties. Find better deals and your numbers just go up from there.

To summarize, tax considerations are a major factor, but also how/where the money will be invested. As others mentioned, cash out refinance could be an option too. Although in your case it will probably leave the property cash flow negative, so I am not sure that is the best idea.

Bill B. · Answer

@Jeremy Clarke

Thanks Jeremy. I’d had never heard of that. Would try to use the “unable to afford basic living expenses exemption”? I didn’t see any others you could try.

If you truly can’t afford basic living expenses I would sell for that reason alone.

Otherwise hold on. You talk about $130k vs $700k in future. But that would be as just a cash out refi and completely tax free.

Joe Splitrock · Answer

@Jeremy Clarke I honestly wasn't aware that there was 0% capital gains for a single person making under S39,375. Given your low income this year, that seems to make this an opportune time to sell.

Of course keep in mind a couple things. You will need to list, sell and close before the end of the year. That means you want to move quickly. The other thing to factor in is selling expense. You will have realtors fees and closing costs. That is likely to eat up 6% to 8% of your gross proceeds. That means your take home profit is closer to $120-130K.

The other thing missing from this equation is monthly cash flow of the property. You talk about gains when selling, but how much are you making monthly after expenses? The question then becomes, when you cash out and get that $120-130K, where will that money be invested at at what rate of return. Basically you want to compare projected return after cashing out, with current return if you stay the course.

I don't think the capital gains rate will be better in the future. Tax rates are pretty low right now and I expect them higher in the future. As we see less of the population able to work (or unwilling) in the future, it will only increase tax burden. Of course 1031 is an option down the road too, but selling for 0% tax is free of any conditions or hassle associated with a 1031.

Dennis Cosgrave · Answer

As I mentioned earlier, if you have a reinvestment strategy where you can realize better returns, then by all means, go ahead and sell. If you have not developed a strategy, I would wait until you do.

Jeremy Clarke · Answer

I would agree, thanks Joe.

Jeremy Clarke · Answer

Yes it was converted and reported in my taxes the following year. You saying "Tax laws are constantly changing. What appears advantageous today could turn into a big negative tomorrow." seems to validate the fact that I should in fact take advantage of this now and not wait, does it not?

Jeremy Clarke · Answer

The trigger of the sales is for tax advantages - nothing else. This is not a primary residence. If i wait two years, then i am subject to a 15% penalty (or more) which would be uncle sam taking roughly $20k or more.

Jeremy Clarke · Answer

Yes it is a capital gain but this year my gains status will be 0%. I have run this scenario with my accountant.

Dennis Cosgrave · Answer

You mentioned that you lived in the house for 18 months. When you converted it to a rental property did you file a change in status at that time? If not, you will have to calculate the market value at the time of conversion and that will be your cost base for calculating your capital gain if you choose to sell. As mentioned previously, I would not sell until you have a reinvestment strategy. There is an old saying; Never let the tax tail wag the investment dog. Always make decisions on the merits of the investment itself, and never on tax advantages. Tax laws are constantly changing. What appears advantageous today could turn into a big negative tomorrow.

The Age Old Question...Sell or Hold?

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