Seattle property - not sure how to evaluate primary turned rental

[Crystal H.]

Hi! Relatively new here, and accidental investment property owner. We bought our first home (primary residence) in 2014 in Seattle (Ballard area for those familiar with the city) We paid $669k for a 4BR/2BA, 2500 Sq Ft home built in 1940. It's walking distance to everything and in a very nice, family friendly area. Has been meticulously maintained; we were only the 3rd owners. We put 10% down ($70k) and have $520k left on the mortgage. Zillow / Redfin + what I've seen in the area it would now sell for $1.05-$1.1M. 

Last summer we moved to Nashville to be closer to family and we kept the Seattle house and are renting it out. It rents for $4450 and when you back out lawn care, property management, etc. we cash flow $200/mo which we just add to our mortgage payment. The strategy was to hang on to it for appreciation. 

As suggested by many, I've been doing a lot of deal analyses just to get the practice, as we want to purchase a rental property here in Nashville with some other funds we have. My question is - how do you evaluate an investment when you switch from primary to rental? For project costs, would I just include the things we needed to do to prep for rental (some electrical work - $7k) or do I need to include my down payment as well? What about other work we did to the home while we lived there (new windows, siding, etc.)? I'm trying to get an apples to apples comparison to evaluate the options of 1. hanging on to it for X more years 2. selling it and reinvesting (1031, perhaps - we are in the highest tax bracket) here in Nashville. How do you decide when to let go of such a huge, appreciating asset and re-invest it in several smaller properties?

[Dave Foster]

@Crystal H., As of right now all of your capital gain would be tax free because you meet the requirements of sec 121 and the gain is still going to be a little less than $500K.  You have the option of holding this house for a couple more years and still meeting the 2 out of 5 residency requirement.  So you do have a little time.  

The other thing you want to keep an eye one though is the depreciation recapture. Each year you use that as a rental is going to cost you around $5K in depreciation recapture.  This can be avoided with a 1031 exchange.  And right now you can actually take advantage of both - take the $500K deduction and do a 1031 exchange which would defer the depreciation recapture.

With a blended approach like this you would need to buy less replacement property at once under the stringent 1031 timelines.  And yet you'd also have $500K of cash in your pocket tax free waiting for the right time to buy - whenever you decide that is.

You have a little time to decide this.  But tax free is always what I prefer.