To cash-out refinance or to sell a family home?

[Alissa Castellanos]

I need help figuring out a best course for my mother and her beneficiaries. My mother owns a fully paid home with a minimal cost of living. She needs assisted living which will greatly increase her cost of living and therefore require her to withdraw more from her traditional IRA, increasing her income taxes. We are trying to decide between keeping the house as a rental or selling it. If she sells, she can pocket all the money tax free and live off of it for several years, leaving much of her IRA in tact. But, she could cash-out refinance it and rent it at least covering the PITI expense with small cash flow. But, if she passes, her beneficiaries will be responsible for any capital gains if they need to sell. I spoke with a Real Estate focused and recommended CPA who leaned toward selling for the lump sum tax free money but I'm still not certain it's the right course. Being of the long term investment mind, maybe I'm biased. The other issue is the house is located about four hours away from all family with the vested interest and is in need of many repairs. So some of the money from a refinance would need to go to repairs including some big ticket items (roof, heating/cooling, septic). We could build equity immediately from repairs and refinance again, the trouble is someone being around for all the work to be done.

The primary focus is my mother not outliving her money and watching a bunch of it get sent over to uncle Sam. I want her to not have to penny pinch in order to keep her IRA withdrawals low, but it's also difficult to watch a family home disappear. Selling is the least amount of work, but we'd also leave a ton of money on the table selling as-is, and I think the only way we could consider taking the time and headache of repairs is to repair it to keep it.

What does this mastermind community think? I'm specifically looking for the big financial and tax pros and cons to all options, and open to other strategies I haven't mentioned and maybe haven't thought of. Thank you!

[Greg Scott]

First, let's discuss one thought that may change your perspective.  When someone who owns real estate dies, their heirs inherit the real estate at a stepped-up basis which means capital gains tax should not be an issue (assuming her estate was properly set up).

It seems like you've thought this through pretty well.  So, I will give you two more angles to think about.

If you do a cash-out refi, that is a non-taxable event.  Per your comments, it looks like you would need to put a portion of that towards fixing up the house, but then would have a nice pile of cash to help mom with.  If you then turn it into a rental, her taxable income should be zero because depreciation should offset any cash flow.  That is also a good time to remove small amounts of cash from the 401K because she will still be in a low or zero tax bracket.

Another thing to think about, taking back-to-back cash-out refis will require you wait 6 months between.  However, with a Hard Money Lender, you can get all the cash out up-front and just do a rate & term refi once repairs are complete.  Generally, this would be a better way for you to go, but only do it if you have confidence in your GC, because you will want repairs done ASAP to minimize the high interest costs of hard money lending.