Will refinancing 3 SFH next year at the same time be beneficial?

Question

TLDR; Will refinancing 3 SFH homes at the same time give me negotiating power to get better rates/lower fees?

Background: We bought SFH1 in 2015 with 3.5% down on a 15 year mortgage. Then we rented it out and bought SFH2 in 2017 with 5% down. We recently rented out SFH2 as well and bought SFH3 with 7% down that will be living in long term.

Concerns: We are paying a lot of PMI right now because we bought all the homes with little down. We've seen considerable appreciation due to the area/timing we bought, which is the reason for us spending so little down. I am trying to decide what to do with the rentals long term but we live in a good growth area (Raleigh) so I am hoping to hold on for at least a few more years.

SFH1 - 150k mortgage, 290k value, rented at $2k/mo, 15yr mortgage is $1700/mo, $90/mo PMI

SFH2 - 245k mortgage, 320k value, rented at $1700/mo, 30yr mortgage is $1700/mo, $200/mo PMI

SFH3 - 320k mortgage, ~400k value, 30yr mortgage is $2300/mo, $325/mo PMI

Looking to make a decision in the summer of 2020, so the numbers above are 2020 numbers. I've heard doing a cash-out refi is tax free on the capital gains, so with SFH1 coming up on the "occupy for 2 years out of 5 rule" I need to make a decision there. SFH2 is close to being 80% LTV now, and SFH3 will be 80% LTV next summer with a few upgrades (that I don't have a problem doing since we're planning on staying there long term).

Assuming I'm not tired of being a landlord by then, this is my plan:

- Cash out refi SFH1 to a 30yr and avoid capital gains on at least 70k of appreciation. This will reduce the mortgage to approx. $1200/mo and give me ~$60k back in the bank for future investments.

- Refi SFH2 at the same time - could this get me slightly better rates or save on refi fees? Maybe I should wait until I come up to the "occupy for 2 years out of 5" deadline 3 years later and do a cash out refi then instead? I'd ideally rent SFH2 until at least summer 2022 anyway.

- Then, spend what is needed (guessing $10k) to have SFH3 appraise for 80% LTV and do all 3 refinances at the same time? Separately from SFH1 and SFH2, I am planning on doing this regardless of the rest.

Basically, the deadline will pass for SFH1 to be capital gains free in the summer of 2020, and I am trying to formulate a plan for continuing to rent SFH1/SFH2 out until at least 2022. I know 1031 exchanges exist, but I am completely unsure if I'd like to do that down the road. I'm guessing I'll be tired of landlording by then. What would you do?

Brian Sparr · Answer

Hi Account Closed -

In simple terms, you get taxed on the difference between your sale price and your "cost basis" - which, for right now, just think of that as your original purchase price.  In reality, the cost basis gets adjusted by different expenses/renovations/depreciation you may have made to the property and the sale price gets reduced by certain expenses ... but let's not complicate this for right now :)  Key thing to understand, though, is that doing a refi doesn't change your cost basis.

You paid $209k and sell for $300k ... that's a $91k gain that you will be taxed on - the Fed will treat it as long term capital gains - depending on your state, it will likely be taxed as ordinary income.

If you've lived in the property as your primary residence for 2 out of the last 5 years, you can shield the entire $91k from being taxed.  If you haven't, you could do a 1031 exchange into other investment property and defer paying taxes on this $91k until a later date.

Brian Sparr · Answer

Hi Account Closed -

As @Tim Sherrod already mentioned, taking money out during a refi is not considered capital gains - you're taking on debt that will need to be paid back - so there is no taxable event.  Avoiding capital gains because you've lived in a place 2 out of the past 5 years only comes into play when you sell.

My recommendation, though, is that if you're considering doing a refi, do not wait until next summer ... do it now!  You have no idea where interest rates will be next month, let alone next summer.

If you're trying to decide whether to hold or continue renting, we'd need to know more about your goals and the current situation (I'm having a hard time backing into some of the numbers you listed above) ... if this is just about pulling cash out and dropping the MI, do it now.

Good luck!

Account Closed · Answer

Thanks @Brian Sparr - this definitely changes things. A 1031 exchange is something I need to look much more into - I'm not sure if that's something I'd want to do or not.

I guess at the end of the day, we'll have to decide:

1. Sell and pay no capital gains OR

2. Keep renting for at least two years (so appreciation/rental income can outpace the addition of the $10-12k in capital gains taxes)

I'm leaning toward the latter, as this is a very good rental and the area has been growing very well so far. It will need a replaced deck in a year or 2 but that's all I foresee needing replaced.

Account Closed · Answer

Hi Tim,

Thanks for your advice. Interesting, so I can cash out tax free with a refi, but I would owe capital gains on the original purchase price down the line still?

So you are saying this example below is incorrect?

What I'm thinking is refinancing at an estimated appraisal of say $275k, with an original $209k purchase price. Would that reset the purchase price to 275k? So if for example, I sell 3 years after the refi at 300k, would I owe capital gains on (300k-275k) or (300k-209k)?

If I still owe capital gains taxes on the original purchase price of 209k, this definitely changes things. Thanks for your help!

Tim Sherrod · Answer

One clarification to your post:

As you approach the “occupy 2 out of last 5 years”, refinancing doesn’t allow you to take advantage of this rule.   Capital gains are triggered on sale/change of ownership, not at refinance.  The decision you’ll have to make is whether you want to SELL it to take advantage of the rule.

This doesn’t address your question of whether you’ll get better rates by refinancing all 3 at once, but I thought it was important to address since much of your post focused on the timing based on “2 out of 5 years”.

Good luck.

Will refinancing 3 SFH next year at the same time be beneficial?

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