Long-term strategy for full-time employee (NYC area)

[Nick Salemme]

Curious on everyone's thoughts on the following strategy I am considering. Note that I work full-time in NYC and live nearby in NJ and want to do real estate on the side as a long-term play and ease into investing. I have already bought my first unit (primary residence) in mid 2016.

The strategy I am considering is simple. Buy a unit (condo, SFH, etc.) as a primary residence in a relatively nice area (but also with a high likelihood of appreciation) that would cash flow in today's market if it were to be rented out. Live in it for 2 years and then buy another and rent the first unit out. In 2 more years do the same thing again. At this point, consider selling the first unit depending on the current market/my need for cash or continue renting the unit out. Continue this cycle of buying every 2 years and re-evaluating whether or not to sell some of the units that have already been lived in for 2 years. Along the way, most of the purchases will preferably need work done (my dad is a contractor) and those can be sort of a longer live-in-flip/rent strategy. Once I have accumulated 4 or 5 units, I want to start using the cash flow and any cash received from any sales to pay down the mortgages. The end goal is to have roughly 5 rental units that are completely paid off and can help supplement my income and potentially give me the opportunity to branch into a different career/lifestyle.

The main reason behind the 2 years of living in the units is that per U.S. tax code 121 (exclusion of gain from sale of primary residence), if you have lived in a unit for 2 of the last 5 years, an individual does not have to pay tax on the capital gains for up to $250k of gain ($500k for married couples). Also, 2 years gives me enough time to save up enough cash for another down payment, without cutting into my excess cash reserves/vacation savings. Another reason for this strategy is that when buying as a primary residence, the financing terms I can get are much more favorable and in turn, increase the future cash flow due to the lower monthly costs.

[Dave Foster]

@Nick Salemme, to @Robert Motch's question you absolutely can take advantage of the primary residence exclusion as long as you have lived in the property for 2 out of the 5 years immediately prior to sale.  So your plan to evaluate after 2 years of living in and 2 years of rental is solid.  Under current law you would have to recapture any depreciation but the gain would be tax free.

If the property turns out to be a good rental then you can always go past that 5 year look back.  You won't have the tax free treatment of sec 121 but you will be able to 1031 exchange if and when the time comes to sell.  And that will be tax deferred.