Current situation. What would you do?

Question

I currently own a sfr. Current loan amount owed is $358,000. Current value of home is $550,000. I have rented this out for the past 3 years and am wondering if I should sell and take equity to put down on another property or should I take a heloc. What’s the best way for me to leverage my equity? Please advise thank you

Dave Foster · Answer

@Angel Rivera, There's a few details missing to make a good call on that for you.  I think what you're saying is that your monthly expenses are $1000 and you are renting it and clearing $500 monthly after expenses.  In the simplest analysis thats $6000 annually on equity of $75K.  That's an 8% return.  But what we don't know is the shape of the building for looming cap ex, your allowances for vacancy and repairs, appreciation potential, etc.

The one thing that sticks out to me and is a personal bias is that you do have the ability to sell that property and take the first $250K/$500K in profit tax free.  I'm a huge fan of tax free.  Even if you put the money back into more real estate.  I always take advantage of tax free over tax deferred every time.Also, former primary residences usually don't make the most efficient/money making rentals.  So unless there's something glaring in those facts we don't know about I'd lean to selling now while you can take the exemption.

Angel Rivera · Answer

@Dave Foster would you consider cash flowing $500 on a property you spend $1000 monthly a good investment?  I’m thinking about a HELOC or selling as well. I’ve got 75k in equity and it’s been rented for a little over 2 years now. I’m coming up on that 2 out of 5 year window.

Mike Flora · Answer

@Varinder Kumar sell it, California market is fragile right now and swings big up and down when those good/bad times come. Either 1031 or just sell and reinvest in another part of the country for a better return. Very tough to get good cash flow in Cali, in SFR, compared to other states.

Dave Foster · Answer

@Varinder Kumar, It sounds like you're past the window to qualify for the 2/5 primary residence exclusion.  If you're wanting to reinvest in more real estate then either a heloc (if you can get one on a rental property, refinance if you cant) or a 1031 exchange scenario would be the way to go.

The issue with a heloc or refi is that you can only tap part of the equity so your buying power is diminished.  And if the rental is not a top producer for you the additional leverage can turn it from mediocre to bad very quickly.  If it's a great producer then you may think about borrowing against it.

The 1031 exchange allows you to defer tax on all gain and depreciation recapture (which is going to be very significant as well).  There's some hoops you have to jump through but they're not expensive and the benefit is tremendous.  The process is no different than what you normally do.  Just know that you must have the qualified intermediary (the person who will document the 1031 exchange) in place prior to the sale of the old property.  If you close the sale and touch the money or the QI is not in place then you forfeit the opportunity to do a 1031.

Karen O. · Answer

You should speak to a tax pro.

If the house was your primary residence for 2 of the last 5 years, you can get a $250k capital gain exemption ($500k if married).  This is all irrelevant if you didn't live there or if you can't move back.

If you sell via a 1031 exchange, you can postpone capital gains taxes while repositioning your investment. There are very specific rules related to this, so again you have to work with a pro to get it right.

As for the rental income, vs rental expenses, $2700 in rent less $2400

in mortgage leaves $300.  However, you haven't indicated any other expenses like taxes, insurance, repairs, capex or property manager.  Unless your mtg payment includes insurance and property taxes, you are not breaking even.

Were I you, if I didn't quality for the primary residence exemption and couldn't move in in order to qualify, I'd be looking for a way out of this investment and into something else.

Bill B. · Answer

@Varinder Kumar

If you lived in the property 2 of the last 5 years you can sell and gain 250k as a single or 500k as a married couple. If you have over $100k in gains and you can complete sale before the five years expires I’d sell. You will still owe 25% tax on the depreciation recapture.

Renting in California has lost most of its luster with possible rent caps, relocation expenses, etc...

Take your $200k and the easy/worst deal is buying a Vegas property outright. Suddenly you’re bringing in $1200 rent and netting $1,000 a month instead of $300. Or put $100k down on 2 $200k properties. Now you have $2400 in rent to pay a $200k mortgage. If you want to be a landlord. Otherwise cashout and move on.

Varinder Kumar · Answer

@Karen O.

So if owner occupied you don’t have yo pay capital gains tax? Capital gains tax only applies to investment properties? Thanks

Varinder Kumar · Answer

@Karen O.

Rent is $2700 mortgage is $2400.

Vinay H. · Answer

TO answer, we need to know what is current rent and cash flow...

Current situation. What would you do?

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