When does it make sense to sell a rental property?

Question

The home has appreciated from $315K in 2016 to ~$450K in 2019, and my rent is cash-flowing positively. The area has exploded with development and growth, but as more and more new properties flood the market, I'm not sure if the growth will continue at this rate. One positive clearly is that that my equity has increased a lot. That said, when analyzing the total value of my equity compared to when I purchased it, the ROI actually decreased due to the amount of capital tied up in the investment.

I lived in this home for 3 years prior to just renting at the beginning of this year, and it's also in an "opportunity zone". So if I wait until 10-years of ownership, I can sell tax free (I believe). If I sold now, I still think I can claim primary residence though and avoid tax up to $500k.

Curious what some folks think makes the most sense. Take chips off the table and reinvest, refinance to pull equity out, or keep payment low (without refinancing) and just ride it out for years to come.

Appreciate any insight,

Joe

Nashid Ali · Answer

@Joe Caiola I don't want to burst your bubble and sorry if I'm missing a detail or two; that said, if you didn't use capital gains to purchase the property through a qualified OZ fund, which I doubt is the case since you've been there for 3 years and the law is only about a year old - you wouldn't be eligible for the tax free capital gains after 10 years.

Jeshua Patrick · Answer

@Jeffrey Lo I’m pretty sure the tax-free loophole requires 2 years of occupancy within a 5 year window not 7 which would only give him 3 years to sell tax free not 5. The $250k single/$500k couple numbers are correct.

Greg Dickerson · Answer

I say sell and put the cash to work. You will not see much more upside and will likely see a downturn soon as we are definitely at a peak in the matket.

Interest rates are the only reason values are where they are right now both in all asset classes. Rates really can't get much lower and if they do it will be due to a slow down and clearly indicate serious issues in the global economy.

Will Barnard · Answer

That’s one opinion. In looking at charts and data, I see a high possibility of rates going down, not up and in many areas of the country, the market continues to remain hot so we may or may not be at the very top. I will admit prices can’t go too much higher so locking in equity now can make sense so long as it is reinvested properly.

I do agree that the global markets and the USA economy as a whole could see declines in the near future causing the feds to push the economy by dropping interest rates. If that happens, it won’t spike home prices, just keep them from falling too far. I recently read a chart that compared our last run up and subsequent crash to today’s market conditions and it shows that the affordability index is higher now than in the last segment leading me to believe we can still have some more price appreciation. That said, I don’t have a crystal ball, if anyone else does, please share with us, lol.

As to to the original question, you should put together a proforma of multiple scenarios and see what is your best return. Option 1. Sell now, use the primary residence of 2 of the last 5 years and have a tax exclusion of $250k if single, $500k if married and use the capital to get into another investment with higher yields. Option 2. Refi and pull out some capital, reinvest that capital into another cash producing asset at higher returns than the cost. Option 3. 1031 into a like kind investment and defer the taxes (if you don’t qualify for the homeowner exclusion).

It’s all about the numbers and your desire to get into something bigger and better or not and remain where you are at with this investment. Choice is up to you.

David Barnett · Answer

@Joe Caiola How much is the cash flow today?  If you were to refinance up to 80% LTV, would it still cash flow positive?  How much is your current mortgage on it?  Due to it being in an opportunity zone, and my understanding of the opportunity zone program, I would probably hold onto it to cash in on the opportunity zone strategy.  My guess (err, maybe educated guess) is that very financially secure folks are looking to cash in the opportunity zone tax legislation - since it's a really great tax deal for them (my understanding).  With a lot of money flooding into opportunity zones, I would venture to guess that the value will continue to explode.

Jeffrey L. · Answer

I would sell so you can still take advantage of the tax benefits (basically no tax obligations for your $135k gains).  There is a time limit though, you need to live in it for 2 years (which you satisfied), and that 2 years of live-in needs to happen in the past 7 years (consult your CPA for exact formula).  So it's not like you can sell this property 20 years later and still claim "tax free."  So check with your CPA to make sure.

With the entire proceeds being tax free, you can then consider using it to purchase the next investment property, which any future gains and tax obligation will start from the purchase price of the new property, not $315k.

Jeff

Brent Paul · Answer

Up to 250k in profits single or 500k in profits if married filed jointly.

You could always sell and do a 1031 exchange to roll that money into another property.  Have you looked at other opportunities in your area?  Maybe a downpayment on a multifamily?

Take out a HELOC on the equity and use that as a downpayment for another property.

Or do nothing.

When does it make sense to sell a rental property?

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