Should I sell my old primary home?

Question

In 2020, I bought my previous primary home with a 20% down payment and a 2.5% 10-year ARM mortgage. Since then, the housing prices have risen about 50%, reducing my leverage from 5x to around 2x. I'm considering purchasing a new home but unsure if I should sell the old one.

My plan is to retain the old home and rent it out. Taking into account my current monthly expenses, including potential vacancies and maintenance fees, it should break even. Considering I'm new to real estate investment and don't own any rental property yet, I believe this is a great opportunity for me to enter the field and learn how to manage rental properties. Additionally, I have sufficient funds to buy another rental property if a favorable deal arises. But not enough for an extra.

I'm located in California, where the property tax yearly increase is capped at 2%. I'm hesitant to let go of the 2.5% interest rate, given that current rates are around 6-7%.

The main reason I'm contemplating selling is the advantage of no capital gains tax for owner-occupied properties, allowing me to access the equity. And also the current leverage is only 2X, there are opportunity costs. Once I convert it into a rental property, I can either sell it with 3 years (there might be some complicated depreciation recapture and mortgage payment tax issue?) or through a 1031 exchange after that. A cash-out refinance appears unfeasible due to the present rent-to-value ratio and the much higher interest rate, as it would lead to considerable negative cash flow.

Timothy Howdeshell · Answer

@Ryan Sun

Seconded what @Jake Andronico stated above. He is also correct on the tax law (source: https://www.ftb.ca.gov/file/personal/income-types/income-fro...). This also applies to federal taxes (https://www.irs.gov/taxtopics/tc701).

From your post you have enough cash to move forward in your journey. While the return on equity in your old primary may be low. I would wait to sell until you have a game for the incoming cash. Treasuries and HYSA are paying well now, but if and when the FED starts reducing rates this will decrease the yield on those investments while simultaneously increasing property values (low rates = increased demand = increased prices).

The only thing that gives me pause is the ARM, but you've still got 7 years left before it adjusts.

The 1 year of rental will still allow you to sell, not pay taxes, and get landlord/investment experience. If you hate it, then sell after the first lease is up. Just make sure it isn't longer than 18 month lease to give yourself time.

Ultimately, you're caught between 2 pretty good options. Given your interest in real estate, I would go for the hold personally. I did this exact thing on my first house.

Bjorn Ahlblad · Answer

I definitely would not sell. The mortgage and the appreciation are just too good completely wiping out any leverage considerations. Your biggest problem will be capital gains and that nasty California State tax. We paid 400k to California when we sold properties in 2015 and 2017. You need to put your heads together with an REI savvy accountant. You will still be taxed but that's what you get for making money. All the best!

Jake Andronico · Answer

@Ryan Sun

It sounds like you can get the best of all worlds here by renting it out for a year. That is a fairly limited amount of time, and you can experiment to see if you even like this business.

Of course you should speak to a tax professional, but my understanding is that if you convert it to a rental property, but have still lived there the last 2 out of 5 years, you should be able to get the Section 121 exemption.

But again, definitely check with a tax professional.

Gregory Saysset · Answer

if you plan on staying in the Area, I will try to keep it, but you also know the house more than anyone, if you think the house is on autopilot and will not cost you much in maintenance, definitely keep it, but if you know thinks are falling a part and you might need to invest a lot in the next few year you might want to sell it.

Have you also look at adding an ADU to the property, that might help get more cash flow, depending where you live in CAL, some area offer help for Financing, and it could make sense for you.

Should I sell my old primary home?

Should I sell my old primary home?

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