Which strategy: sell, buy, house hack?

Question

DW and I inherited a house in New York City a few years ago under a Trust to which we are both the executors on. Since the house has no loans/lines we are considering using it as a stepping stone to start investing in real estate. We want to purchase a multi-family home in Southern California. DW, wants to "house hack" the new property as she believes we would be considered "first time buyers" thereby making us eligible for an FHA loan. Under her plan we would use savings to put the 5% required down payment. The rental income from the NYC inherited home, and the SoCal house hack would more than cover our new mortgage. Since Covid-19, I feel this is too risky because if the renters in either property can't pay, we'd be stuck with a huge mortgage to cover ourselves. My strategy is to sell the NYC house and use the proceeds to house hack the SoCal property, which even with renting out the additional unit we would be able to fully cover the mortgage ourselves should anything happen. Please help settle the score as well as educate us as to whose strategy is better for green investors.

Jason Lee · Answer

I should speak to an estate attorney to see if the trust qualifies for the cap gains exclusion. I would also speak to an accountant to figure out the tax consequence if it doesn't qualify. If it's only been a couple years then you would only owe tax on the gain within those years (minus the capital improvement costs) since you got the house at the stepped up basis. Depending on where and what the property is, the cap gains could be quite small, or none at all.

Jason Lee · Answer

What are the current tenants like? Have they been there long term? Do they still have their jobs and are they still paying rent on time? Despite cries of the sky is falling, the majority of rents were paid in May and the ones that weren't were at the lower end. Where is the house located and at what price points are the rents? If you think you're going to lose sleep at night you have the opportunity to sell at the stepped up basis. @Twana Rasoul Compass in the house!

Brandon Carlson · Answer

@Robert Yarborough Great idea on the house hack. I've been doing it myself for the past 3 years in my SFR. It works out since I don't have kids and a good buddy of mine rents a room from me for $850 a month. I'm thinking of getting a duplex myself. Since I own a home, FHA is out of the question, plus having PMI for the term of the loan, is a blow to your cashflow. Have you decided what part of SoCal your interested in?

Robert Yarborough · Answer

@Will Fraser the only other markets we'd be interested in are the Tri-state, SoCal and Atlanta ones.

Robert Yarborough · Answer

@Paul Moore Capital Gains taxes is one of the main reasons why DW prefers not to sell, we have started researching what a Delaware Statutory Trust (DST) is thank you for your suggestion.

Robert Yarborough · Answer

Thank you all for your responses. We renovated and moved in to the inherited NYC house a couple of years ago so it is considered our primary residence even though it remains under a trust. I did a rent comparison and it looks like we could get somewhere in the $2K+ range for the property if we rented it out, and moved to SoCal with the newly purchased "house hack."

Paul Moore · Answer

@Robert Yarborough. Welcome to BP! I imagine you want to be actively involved in investing. But if you decide to stay passive, and still get the tax benefits and income of ownership, I believe you could do a 1031 exchange to cover your likely stepped-up basis, then invest the proceeds into a Delaware Statutory Trust (DST). This would allow you to shield taxes, obtain income and appreciation, and have the asset fully managed by a professional. A win-win for many investors.

Twana Rasoul · Answer

@Robert Yarborough I don’t know enough about your NYC property to touch on that but definitely house hacking here is the way to go. I house hack here myself in a great neighborhood and I wouldn’t do it any other way.

Scott Wolf · Answer

@Robert Yarborough, is the NYC home already rented out? If so, you can 1031 exchange it into a new investment property. But it seems like the NYC home has just been sitting vacant. I'm sure you have a stepped up basis from the inheritance, but there will be some capital gains involved.

Will Fraser · Answer

Hi @Robert Yarborough, welcome to the BiggerPockets forums!It is quite difficult to assess what you should do without knowing your goals, so I'd recommend getting as overarching about that as possible, and then getting granular.It seems like you might have a favorable tax-basis situation with the NYC home (obviously verify all of this with the right competent professionals . . . i.e. not me). This could allow you to cash out of that and reinvest into the house-hack AND buy a small stable of cashflowing rental properties in another, more ideal market. OR you could do something totally different, but if your goal is to scale in real estate investing this is one route to that.Side note: FHA loans are not reserved for first time homebuyers. So long as you are otherwise qualified for the loan, and you do not already have an FHA loan you're good to go!