We’d like to buy a new home + keep our current as a rental, but..

Member since 2019 · 7 posts · 3 votes

Weighing the pros and cons of a scenario where we keep our current home as a rental, as we buy and move into a larger place. Our small house is in a great area of Eagle Rock where rent will cash flow positive. In the last five years, the house’s value has gone up more than $200k. We have a 3% loan and low payments. We’re approved to purchase another home without the need to sell. My biggest hold up is accounting for the loss of capital gains tax exemption, and being on the hook for taxes on the gains if we decide to eventually sell the rental. How do we get around this? Move back in for two years before selling? Any thoughts from people who have been in similar dilemma’s welcome, as well a those who know the LA market! Thanks! -Jeff

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Steve Jones

Investor · Los Angeles, CA · Member since 2016 · 72 posts · 55 votes

Keep the home and never sell!

Warren Buffet said: "Our favorite holding period is forever." This is buy-and-hold investing, pure and simple.

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Jon Schwartz
Realtor · Los Angeles, CA · Member since 2018 · 952 posts · 1k+ votes
7y
I'm in a very similar situation: my wife and I are shopping for a duplex to house-hack, and since we don't *need* to sell our home to purchase the duplex, we're strongly considering renting our current home when we move. We're in Echo Park, so similar dynamics in terms of appreciation ($200-300k gain in value since we purchased in 2015).
Unless I'm mistaken, once your current home becomes a rental, you can 1031 exchange it toward another rental property when you sell. Have you considered just keeping the ball rolling when it's time to sell that home?
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Nabil SuleimanBusiness Member
Real Estate Agent · Los Angeles, CA · Member since 2016 · 596 posts · 299 votes
7y
@Jeffrey Waldron
1031 Exchange will be your best route, If you have a property that cash flows in an area where you have tenants that you would want to keep long term, the only reason to sell is because of the opportunity to purchase another investment. If that occurs you have the 1031 option to take advantage of.
The questions to ask if you decide to purchase something else and have this is a rental would more or so be, What reason would you sell it for? i.e if you needed money immediately, you can HELOC against the home when the time came that you needed the money, you wouldn't get taxed, you wouldn't pay commissions, closing costs, transfer taxes and you continue to hold onto your asset.
Hope that helps, and congrats!
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Steve Jones
Investor · Los Angeles, CA · Member since 2016 · 72 posts · 55 votes
7y
Keep the home and never sell!
Warren Buffet said: "Our favorite holding period is forever." This is buy-and-hold investing, pure and simple.
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Marco Lopez
Real Estate Agent · San Antonio, TX · Member since 2019 · 27 posts · 6 votes
7y
Assuming the property location has a positive long-term outlook and buy and hold fits with your long-term goals. The only question that I would be concerned with is the ROI (return on investment) on the money.
If you forgo the opportunity cash out on your home. There is a dollar amount associated with this decision. That would be your net proceeds from the sale. There is also a net gain from the positive cash flow the property will produce every month. I would add this monthly income for the year and divide it by the net proceeds for year 1, 2 and 3.
This should assist you with determining if this the highest and best use of your money.
I hope that helps!
Marco
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Ted Stewart
Investor · Walnut, CA · Member since 2015 · 4 posts · 3 votes
7y
You can purchase the new house and keep the old one as a rental. You can sell the old home within 5 years with a capital gains forgiveness up to 500k if you're married, or 250k if you're single -- as long as you lived in the old home 2 out of the last 5 years. So if you moved out today, you have until June 4th 2024 to sell the old home without having to pay the capital gains tax.
I'm not a tax expert or anything, so you should definitely check with your CPA to make sure. This is just how I remember the conversation going when I asked my accountant about a similar situation.
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Jeffrey Waldron
OP
Member since 2019 · 7 posts · 3 votes
7y
Thanks for the responses! My instinct has always been to hold LA real estate -- we let our first condo go to trade up to our current house and I regret it, looking at how well its done and the lost rental potential over the last five years!
"What reason would you have to sell?" is the great key question as the tax penalty only kicks in on a sale. If the sale is to invest in another piece of property, the 1031 exchange saves us. The great equity we have (our would-be tenants would basically pay off the house completely in about 11 years), seems like a good starting point for getting into BRRRR via cash-out refinance. Another potential long term plan has us moving back in for a couple of years when our daughter goes to college, and cashing it out after that tax-free.
And either way, we have two years and change to decide after moving out before the primary residence exemption disappears.
Does anybody happen to know if the 1031 would apply toward a new primary residence down the road? Or only investment properties?
Thanks again for the insight -- any additional is so welcome, we're close to taking the plunge! Any scenarios / recommended numbers we need to run before diving in also appreciated!
-Jeff
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Ted Stewart
Investor · Walnut, CA · Member since 2015 · 4 posts · 3 votes
7y
1031 is for like-kind properties only. So rental must be exchanged for a rental; usually of greater value. So if you gain 500k, then want to do an exchange on a property that is 400k, you would still have to pay gains on the 100k that you cash out. If you want to move in to the property that you're exchanging for, you must wait some time. Most accountants say 2 years to be safe, but the IRS does not define this time period explicitly.
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Jeffrey Waldron
OP
Member since 2019 · 7 posts · 3 votes
7y
@Ted Stewart My understanding was that I'd basically have three years to sell as the first day of the five year period technically started two years ago.
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Ted Stewart
Investor · Walnut, CA · Member since 2015 · 4 posts · 3 votes
7y
Originally posted by @Jeffrey Waldron:

@Ted Stewart My understanding was that I'd basically have three years to sell as the first day of the five year period technically started two years ago.
Yeah you could be right. Definitely check with your accountant before proceeding.
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Eric Carr
Real Estate Broker · Los Angeles, CA · Member since 2017 · 655 posts · 293 votes
7y
@Jeffrey Waldron
@Jeffrey WaldronSeems like you might be in loss aversion mode over the cap gains exemption. Eagle Rock has been hip since I can remember way back - used to hang there in the 90's, and growing. You will have renter demand. If it were me, I'd hold on. You can always sell within 3 years and maintain your cap gains exemption if you choose. Keeping it means you will have renters pay the house off and provide you with tax free cash flow for now, and cash flow for life. 1031 is another option, as you know. A HELOC can give you tax free cash if you ever need it. To me, the property is far more valuable as a long term hold. You might need to decide, are you looking for short term or long term gains? Each offers a unique tax advantage. Short Term Rentals is another option
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Jeffrey Waldron
OP
Member since 2019 · 7 posts · 3 votes
7y
Thanks @Eric Carr -- for the words of wisdom and the vote of confidence. Could you explain how cash flow in the short term is tax free? (Because offset by expenses / mortgage interest / etc.?) Thanks!
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Jeffrey Waldron
OP
Member since 2019 · 7 posts · 3 votes
7y
Another question for the LA folks -- is there a workaround for the short term / vacation rental restrictions that are going into place now? We did short term rentals on this property for four months earlier this year while in New York on business and did very well. Would love that to remain an option.
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Nabil SuleimanBusiness Member
Real Estate Agent · Los Angeles, CA · Member since 2016 · 596 posts · 299 votes
7y
@Jeffrey Waldron have you looked at ADU options for your current or future properties? if you live on site in one of the units you can rent out the other year round.
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Eric Carr
Real Estate Broker · Los Angeles, CA · Member since 2017 · 655 posts · 293 votes
7y
Originally posted by @Jeffrey Waldron:

Thanks @Eric Carr -- for the words of wisdom and the vote of confidence. Could you explain how cash flow in the short term is tax free? (Because offset by expenses / mortgage interest / etc.?) Thanks!
I'd take a guess that even with depreciation, interest, property tax, repairs, expense, and mileage deductions, that with a short term rental situation, you'd have a tax gain. But a ton of that income would be shielded and you'd have money coming in every month. I think you're far less likely to show a tax gain with a long term renter.
Last I heard, LA was pushing around a few things to clamp down on STR's, especially on properties that are under RSO. I think it's inevitable that something gets passed, but I'd be surprised if it applied to SFH's. Definitely part of the research you should do before furnishing the place. If the current furnishing will remain, you could do STR until you cant, then adjust. Either way, the house is more valuable while you hold, unless you aren't looking at the long term gains and long term possibilities such as 1031 and or leaving it to your daughter
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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
7y
@Jeffrey Waldron, I think you're centered on the right pain points and getting some good discussion. From the 1031 perspective you do have up to three years after converting the primary where you can sell and take that exemption. so you've got a long runway. But if you decide to continue holding after that point you'll have the 1031 option.
I'm a big fan of tax free and taking chips off the table. But in your case you've got 3 more years before it's even a decision. Unless you feel that you could sell now and invest tax free into an area with stronger short term appreciation potential.
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Jeffrey Waldron
OP
Member since 2019 · 7 posts · 3 votes
7y
Thanks again everybody for the insight!
One more question comes to light as I continue calculating: I believe the property is cashflow positive at comparable rental rates in the area -- but not significantly so. If it ends up renting at a little better than breakeven, is this still a good move? There are 11 years left on the mortgage -- so in that time frame renters will basically buy us the house.
Are taxes only applied to profit after expenses (mortgage, maintenance, etc.) -- does the IRS come after any of the equity the renter is feeding the loan all year?
Thanks as always -- this is an incredible resource for knowledge!
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John Sharpe
Crestline, CA · Member since 2018 · 63 posts · 70 votes
7y
@Jeffrey Waldron
The amount of principal being paid down isn't considered an expense by the IRS, whereas the interest on the loan of a rental property is an expense you can write off against your profits.
HOWEVER, as a rental you'll get to write-off depreciation on the house. This could be very helpful.
It's best to have a trained tax person go over it, including how the IRS will want to"recapture" the depreciation if/when you sell, and why it could be very helpful to do a 1031 exchange if/when you sell.
Depreciation and the ability to do 1031 exchanges are huge benefits to landlords, if you go that route.
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