Purchasing Rental with Home Equity?

Question

I am looking for some advice on our situation.  Our goal is cash flow passive income with rentals.  We are currently living in a single family home that we own free and clear.  We are also interested in moving to upgrade our home.

Here are the scenarios I can think of. Is there a scenario I am missing? I am looking for recommendations for those with experience with this situation.

1. Since we have lived in our current residence for about 15 years we could sell the house and not be taxed on the capital gains.Use the cash as down payment for a new home and use the rest for down payments on rentals.

2.  Get a home equity line of credit on our current home and use it for a down payment on a new home and rent it out older home once we have moved out.(We would miss out on the tax free capital gains sale in the future?)

3.  Refinance our current home and use the funds for down payment on new home and rentals.  We could rent out this home (again we would miss out on the tax free capital gains for not selling the home).

Aaron Lovett · Answer

Another way to look at the situation: If you had no home, but a pile of cash equal to the value of your current home, would you use some of that money to buy the home you live in now and turn it into a rental?  If you would, then keep it and borrow against it by refi or HELOC.  If not, sell it and find yourself a new personal residence and more appropriate rental properties.

Patsy Waldron · Answer

If you *know* you want to buy a new personal residence, I think you should sell what you own now and split the proceeds of the sale between down payment on your new home and however many rentals you can get for the rest of the proceeds. Reasons being:

1. Market is hot now, and you could get top dollar for your current home. Who knows what the market will do in the short to medium term. [The flip side of this is, of course, that you will also be *buying* your new homw at the height of the market.]

2. I dislike HELOCs. Unless there is no other way to get money, I prefer to stay away from them, especially on a primary residence. High interest rate, and loan can be called at any time.

3. If you rent out your current home and don't sell within 3 years, you lose the homeowner exemption on capital gains tax. A waste of a tax break, if you ask me.

4. For your new residence, as an owner-occupant you have several attractive options. Low down payment FHA or conventional loan, which leaves more money from the sale to buy more or better rentals; the option to buy a small multi family property (2-4 units- if you are up for sharing walls with your tenants!) and having your tenants pay part or all of your mortgage- thus freeing up money for the next DP on an investment property; and finally, if you were considering all types/sources of properties, priority consideration for HUD, Fannie/ Freddie properties, and a couple of rehab loan options (203K, HomeStyle) if you need to bring the house up to your standards.

Aaron Lovett · Answer

Thanks Rene G. - I think selling sounds reasonable, especially if your house is better suited to be a homeowner's personal residence than as a rental property.  That's a factor that I don't think has been mentioned but really should be considered carefully.  The tax savings is another factor in your favor, but that shouldn't be the only deciding factor.  In some situations the rental income, future appreciation, equity available, or interest rates might outweigh the tax savings of selling now.  Have someone qualified look over the numbers with you if you are at all in doubt.

The reason I suggested looking at your situation in that manner was to take the emotional and inertial aspects out of the equation and narrow in on the pros/cons of keeping/selling your personal residence.  I know you asked if there were other options, but I think you summarized the options pretty well.

If overall you'd have more money to work with and a better place to live by selling and using that money to upgrade your own home and start your rental property business, then you've found your answer.

Keep us posted on how it goes!

Rene G. · Answer

Great advice here Aaron!  There seems to be a lot of moving parts and having someone qualified to look over the numbers is a good idea.  Tnx!

Rene G. · Answer

I agree Aaron but I don't know if I would want to pass on the Tax Free Capital Gains by doing this.  I am thinking it would be more beneficial to sell and take the tax break then purchase an equivalent home for a rental.  Tnx

Rene G. · Answer

Yes, I did catch that on your last post.  I was thinking longer term like 10 years.  Thanks

Patsy Waldron · Answer

Well, you CAN take it later- you get it if you lived in the house for 2 out of the last 5 years. So you'd still get it if you keep the house now and sell after renting it out for the next 3 years.

Rene G. · Answer

Thanks the response @Patsy Waldron!  I agree, I didn't want to miss out on the capital gains tax break but didn't know if there was some way to delay it and take it later. Thanks for the advice, I will continue to evaluate the options.  :-)

Ryan Murdock · Answer

Keep in mind many HELOCS require you to bring them to a zero balance at least 1x per year so if you are not prepared to do that somehow with your Option #2 it may put you in a bind.

I like #3 so long as the numbers make sense in keeping your current home as a rental (and don't over leverage...).

Purchasing Rental with Home Equity?

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