Should I Sell A Property After House Hacking?

Question

Hi All!I just moved out of a house hack (duplex) that I lived in for over 2 years. Since I purchased it, it has appreciated by about $80,000.

I learned that if you have owned and occupied your property for at least 2 of the last 5 years, you can avoid paying capital gains taxes on the first $250,000 of the gain. Based on that, it seems to me that selling the property in the next three years will be the only opportunity I have to capture the equity without borrowing on it, utilizing a 1031 exchange, or having to pay taxes on the gain.

I understand that my goals and financial situation could affect my decision, but my question is: Is that a legitimate reason to sell the property? Or is there something that I might not be considering/ understanding correctly regarding this rule?

Thanks!

Julien Jeannot · Answer

@Christopher Fovel

As you have pointed out, it all starts with the end goal under which it could be sold or hold on to.

Aside from goals, its a long term ROI (5-10yr) math exercise.

Terrence Terrell · Answer

I would talk with your accountant before making any decisions. If it were me, I'd weigh several factors. What would you use the money for? Are you making a profit with it as a rental? Do you want to continue managing the property? It sounds like you're understanding the tax law correctly, but like you said your goals and financial situation will make that decision for you.

Christopher Fovel · Answer

Thanks for the input everyone! Definitely will be a conversation with a tax professional.  @Andrew Postell I agree with you and think it makes sense to reevaluate in two years. I am not having any issues with it at this time, so it's not like I'm dying to get rid of it today. @Dave Foster and @Michael Plaks - Thank you for that information! I did not think about taxes on the gain for the side I rented!

Leo R. · Answer

@Christopher Fovel selling vs. holding depends on things like: the grade of the property and neighborhood, the ease (or difficulty) of managing the property, the potential for future appreciation and rent increases, the cashflow, the goals and position of the investor, the rate and terms of the debt on the property, etc., etc.  Unfortunately, you didn't mention any of these factors.  ...as you mentioned, it also depends on tax ramifications--I'll leave that question to the CPAs.

Have you run financial projection models to estimate how much this property might appreciate, and how much it will cashflow with rent increases in the next 3, 5, 10, and 15 years?  If you haven't run those types of projection models, I'd highly recommend doing it--this will give you a  much better understanding of the pros/cons of holding vs. selling.

Is your reason for selling so that you can take the money and buy more real estate?  ...if so, then this may be a tricky needle to thread. Since you've owned your duplex for over 2 years, I assume you're locked in at a low rate, but a new property would have a much higher rate (and the price would also be high in today's market). $80k isn't a huge down payment in most markets, so even with that money to put down, finding cashflow at a new property would be a challenge right now.Since you've already house hacked this place and gained valuable experience in that process, it might be smart to just keep that duplex, and go out and try to find another property to house hack again--rinse and repeat. If a strategy has worked well in the past, I'm inclined to repeat the strategy over and over until it doesn't work anymore...

As a general rule of thumb, I don't like to sell properties unless there's either a ton of equity, or there's a real problem with them (for instance, if a property is a huge headache to manage).

Good luck out there!

Michael Plaks · Answer

@Christopher Fovel

You did not have a "house hack" for tax purposes. You had a duplex, which, for tax purposes, is two properties: one personal and one rental.

Two different sets of rules apply. On your personal unit, you can sell tax-free, up to $250k of profit, as long as you sell within 3 years of moving out. On your rental unit, capital gain rules apply.

So you have $40k tax-free and $40k taxable. You can, in theory, do a 1031 exchange for the rental $40k portion. It may not be worth it for this modest amount of gain, however.

And nothing you can do to erase this $40k of taxable gain. You can only postpone it indefinitely if you do pursue a 1031.

Dave Foster · Answer

@Christopher Fovel, Important to note that you will be able to get up to $250K of profit tax free.  But only on the side you lived in.  You will still have to pay tax on the profit from the side you have rented.  But you. are able to sell and take the profit from your primary side tax free.  And do a 1031 on the other side.  That's how you can ensure you pay no tax on the sale.

Andrew Postell · Answer

@Christopher Fovel I have done this with my own primary homes before as well.  When I moved out, I rented for 2 additional years.  Not 3 years though...because I have to market it...that takes a couple of weeks...then someone rents it...and then I have to market it again to sell...that might take a couple of more weeks/months type of thing.  So, you can get 2 years of rents but more importantly 2 years of appreciation as well.  Selling a property RIGHT NOW...you might be selling in a little bit of a down market.  Now, could the market be down again in 2 more years?  Sure.  And if it is, then just continue to rent it.  Having a good rental property is not a bad thing.  Then much later you could use the 1031 exchange thing (which I have also used too).  But when you are coming up towards the end of that 2nd year lease ending...now we can analyze if selling it then is a good call.  And if you do, then tax free money!  That's how we did it and it worked out very well for us to do it this way.

Scott E. · Answer

It's a tough call. It appreciated $80k but after you pay your commissions and closing costs what will you walk with if you sell... $60k in profit? We're not talking about a huge tax bill here. If the net profit would be $200k+ that's another story.

Probably only makes sense to hold it if the property cash flows, doesn't have a lot of deferred maintenance, and it's in a great location.