BiggerPockets Real Estate Podcast

Should You Sell Your House or Rent It Out?

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346 Articles Written
property, for sale, real estate, investment, reinvestment

Two of the best strategies for getting started with real estate are:

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  1. Go the FHA route, and buy and move into a house for 3 or 3.5 percent down.
  2. Turn that property into a rental.

On an upcoming episode of the BiggerPockets Podcast, Brandon Turner sits down with real estate agent and investor Robert Jones to discuss whether people thinking of selling their home should rent it out instead. Below is a snippet of the interview, which will be released in its entirety June 27th.

Should You Sell Your House or Rent It Out?

Brandon: Buying property with an FHA loan alone doesn’t mean it’s going to be a good deal, right? But what you did, you bought a fixer-upper or something that needed to be a total remodel, and you did the work yourself—so sweat equity. You got in there. But then the second thing you did that was cool is that you turned that first property into a rental. That’s probably the number one way that I hear people get into real estate, “Yeah, I just turned my house into a rental property.”

Do you advise that for other people today? Because you, as an agent, you'd probably rather have them sell because you get money.

Robert: No, absolutely. Investment real estate is a big part of my business—for building millionaires, building investors. So if the property makes sense, which most of them do—especially younger clients of mine, they’re living in houses that would make good sense as a rental—that is my absolute first and foremost advice.

And even looking at tax strategies. You still have three years to make a decision, moving out of your primary, with capital gains rules. So yeah, I advise people to keep their existing home if they have the ability to.

And the laws related to qualification and income—even for new landlords—that’s eased up over the last couple years. So it makes that transition easier as far as qualifying for both mortgages. There’s much more leniency there now, too, compared to a few years ago.

first-rental-down-payment

 

Brandon: And if people are wondering what that means about the capital gains thing, I’ll explain that real quick. Correct me if I’m wrong here. Basically, the government says, “Hey, if you live in a property two of the last five years, you don’t have to pay capital gains when you sell. And again, we’re not CPAs, but the gist is you’re not paying cap gains if you live in the house two of the last five years.

It doesn’t mean the immediate two previous years, it just means two of the last five.

So I actually did the same thing recently. I lived in a house for several years, sold it—I think I made like $85,000 in profit. Well, I shouldn’t say I sold it, but there was two years in between when I stopped living there and when I sold it. I still got to claim that two-year thing, because I lived in there two of the last five. It just wasn’t the immediate recent two years. So that’s why you have a couple years to decide.

So a lot of people ask me that question: should I rent my house or should I sell it? And it’s a hard question. I mean I like to say, “Yeah, you should just rent it out, because it’ll get you into real estate.”

But if you’re going to lose a hundred grand in taxes, then maybe you should have just sold it and dumped it into something else. What do you usually tell people when they say, “Should I rent it or sell?”

Robert: Yeah, 95 percent of the answer is, “Keep it as a rental.”

If they have the fortitude or personality type that it’s going to work and if it’s a house that makes sense… which in our market, most houses will rent for what your mortgage is—especially if you got the mortgage a few years ago. And even if it’s running skinny, if you only own one, two, or three properties, you can take on a little bit tighter deals, as opposed to say owning 10, 20, 30. So I think you could be a little more risk tolerant in the beginning on deals that might be a little tighter.

Are you debating between renting and selling? Do you have any follow-up questions for us? 

Leave them in the comment section below!

Real strategies that work for real people seeking to build wealth through real estate investments. Co-hosted by Brandon Turner and David Greene, this podcast provides actionable advice from investors and other real estate professionals, who chat about failures, successes, motivations, and lessons learned.

    Tom Phelan Real Estate Investor from Miami, Florida
    Replied 3 months ago
    I think there may be one “Fly in the ointment”. You can’t move out of a personal residence into a newly purchased residence in June 2019, and in 2021 claim an exemption on the orginal personal residence and also claim your newly acquired residence now qualifies as well if you were to sell it. This could be huge if you moved and waited almost three years, e.g. 2019 – 2022, to sell your original home and claim a personal exemption. That would work but claiming an exemption on your current home would begin to run in 2022. When you sell your original home that was converted to a renatl why not just 1031 Exchange it and move on?
    James Free Rental Property Investor from Fort Collins, CO
    Replied 3 months ago
    I was thinking the same thing. 1031 is the better way to go for investors, though presumably the article is talking about people who are giving REI a trial run and want an out in case it’s not for them, so a 1031 wouldn’t appeal to them. The risk of losing the exemption on your new/current home is worth noting, but not likely to impact a lot of people.
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 3 months ago
    this is not tax advice. seek the help of a professional. it is a little more complicated than this article. sell or keep and rent involves complex calculations of discounted cash flow analysis to answer the question. the IRR for selling may be higher than the IRR for renting depending on the direction of the market and the assumptions. if you rent then sell within the qualifying period for the section 121 exclusion, then you still have to pay depreciation recapture tax of a flat 25%. you can’t skip the tax treatment. most people dont fully understand the section 1031 exchange. it defers the tax due until a later time and does not remove the tax. in a hot market a section 1031 exchange may not make sense. all the parties know the tax payer is participating in the section 1031 exchange. Tax payer sells his/her property A with a section 1031 exchange. on the tax payer acquisition of property B the seller of property B knows the tax payer must buy to comply with the exchange rules to defer tax. if the tax payer ends up paying a premium of 15% or more (very common), then there was no point to the section 1031 exchange when the capital gains on the disposition of property A was 15%. the only people that made money was the broker churning his client. the 1031 exchange decision also requires complex discounted cash flow analysis.
    Tom Phelan Real Estate Investor from Miami, Florida
    Replied 3 months ago
    Michael, I worked for a 1031 Exchange Company and witnessed hundreds of 1031 Exchanges across the country . I never saw a Seller hike up the purchase price of the “Replacement Property” because the Buyer was conducting a 1031 Exchange. True, it is best for the Buyer/Exchangor to state in the Offer and Purhase Contract: “Seller understands Buyer is conducting a 1031 Exchange and will cooperate at no additional cost or liability.” Regarding the complexity of a 1031 Exchange and the Buyer not understanding how it works, you should probably include the Seller, the Realtors, Mortgage Broker if any, Lawyer and Tax Consultant. The 1031 Exchange Company I worked for received dozens of calls every day from CPAs, Accountants and Attorneys seeking information and help. After receiving it for “Free” most bill their clients for “Research”. There are dozens of 1031 Exchange Companies ready, willing and able to provide FREE 1031 Exchange information. You state, “… most people dont fully understand the section 1031 exchange. it defers the tax due until a later time and does not remove the tax.” This is not 100% true, you can actually beat Uncle Sam and the long arm of the IRS regarding deferred capital gains taxes and never have to pay the taxes simply by doing one thing, die. Your heirs inherit on a “Stepped-up” basis and voila, during your entire lifetime even with a long series of 1031 Exchanges you personally never had to cough up deferred taxes on 1031 Exchanged properties.
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 3 months ago
    i have observed buyers paying a premium on too many transactions to count. often it happens when the buyer needs more time and seller wants more money knowing the buyer needs to complete the sale for the second part of the 1031 exchange in a hot market with competing buyers. yes, heirs get the stepped up basis which requires the tax payer to relinquish ownership of the asset. there is no way to avoid the tax for the tax payer without relinquishing ownership (unless you have a lot of money and some very high priced tax attorneys)
    Christopher Smith Investor from brentwood, california
    Replied 3 months ago
    My first rental (20 years ago now) was a personal residence that I had built new. Only got to live in it for a few months before I was transferred about 70 miles away for a significant job promotion. Its been a very solid and reasonably profitable rental over that entire time. Not as profitable as any I have purchased subsequently specifically acquired as rentals, but a respectable return (maybe averaged out to be about 8%) that I can live with. I’d say it ultimately depends upon the timing, location and property characteristics. It was a modestly upscale 3/2 in a very rapidly growing area that has continued as such until this date. So its had lots of demand and has never been vacant for more than a month. However, I think it more the exception than the norm that this turned out as well as it did. A good decision on location, nice neighborhood fit and a substantial amount of good fortune made the difference. Its my guess that more like 1 in 5, to 1 in 10 “accidental rentals” will have this positive of an outcome, not 95% for sure.
    Tom Phelan Real Estate Investor from Miami, Florida
    Replied 3 months ago
    I have never heard of an owner of a rental property having to give up Title in order for his Heirs to inherit on a stepped-up basis. Are you referring to some kind of “Trust”? Can you be so kind as to cite what authority told you this. As far as an Exchangor competing for a house and running out of time because of competing “Offers” on the Replacement Property, this is why the Exchangor needs to identify up to three (more if done correctly) properties with one possibly being an Open TIC. If properly structured the Exchangor won’t close on his “Relinquished” property until he/she is under contract on the “Replacement” property. Once under contract few Sellers would be so foolish to try and jack up the price and risk breaching the contract. And, if somehow a Seller was this foolish, because the Exchangor had also identified two other properties, he/she could switch to one of them. Complicated? Yes. Doable, yes if the right 1031 Exchange Intermediary works with the Buyer from the day he/she lists his/her property. Maybe even before. This is why Realtors and Investors should know suffiient information about 1031 Exchanges to know when to seek help (FREE) from a Qualified Intermediary from day one.
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 3 months ago
    Heirs cant inherit property unless the owner gave up title by dying and passing the property to the heirs. The owner is dead. Title passes to the heirs. i dont recall the section of the tax code or the forms. the heirs receive stepped up basis of the decedent’s assets which is generally the fmv on the date of death unless the executor files for an alternative valuation date/and or method. it is actually more complicated. the inherited basis is the lesser of the adjusted basis or the fmv. there can be additional modifications to the basis including, but not limited to, capital loss carryovers, net operating loss carryovers, passive loss. there are some complicated ways to transfer ownership assets held by an entity at a stepped up basis gifting interests in an entity and avoid some tax on gain. the giftee would have some gain above the gifted basis upon disposition at a later date. agreed on the reason for identifying multiple properties. some exchangors dont do it for a variety of reasons. incompetent counsel being one of them. some exchangors dont want to lose the earnest money when there are no contractual reasons to back out. If the buyer needs more time, then that is the buyer renegotiating the terms of the contract. As part of renegotiating the terms of the contract the seller should ask for more money in a hot market. There is no breach of contract unless a party fails to perform according to the terms of the contract. I have yet to meet a realtor that knows as much about section 1031 exchange as they should know. That kind of knowledge is mostly with the commercial firms.
    Eric V. Rental Property Investor from Red Bank, NJ
    Replied 3 months ago
    Is there not the option for the owner to move into their 1031 and live in it for 1 to 2 years, and then sell and claim it as their primary?
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 3 months ago
    depends. the tax law is not precise from what i can tell. one key is showing intent that you acquired it for investment purposes during the exchange. after the exchange you treat it as a bona fide investment for a period of time which does seem to be explicitly spelled out in the tax code. there are some rules called safe harbor rules that you will want to discuss with your tax professional to ensure you show investment intent prior to turning the property into a personal residence. there still may be some depreciation recapture tax.
    Tom Phelan Real Estate Investor from Miami, Florida
    Replied 3 months ago
    Yes, and 2-years is better than 1-year. The IRS does scutinize intent.
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 3 months ago
    keep in mind you will need to keep the property for at least 5 years post exchange for a section 121 exclusion conversion before selling. while there is nothing in the tax code that says 1 year qualifies as intent i would agree with Tom that the property should be used as business/investment for two years post exchange to help validate post exchange business/investment intent. after one year of use as a principal residence it is considered personal use no longer business use. you could use it for business three years post exchange and the last two years as a principal residence for the section 121 exclusion.
    Tom Phelan Real Estate Investor from Miami, Florida
    Replied 3 months ago
    Michael, You state “you will want to discuss with your tax professional to ensure you show investment intent prior to turning the property into a personal residence. there still may be some depreciation recapture tax.” While this is better than not seeking tax help, if your interpretation of “tax professional” is an Accountant, CPA or Lawyer, why suggest your client spend the money unnecessarily? Why not call a 1031 Exhange Intermediary and get all of the information FREE?
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 3 months ago
    quite a bit of free information can be obtained from a 1031 Exchange Intermediary regarding the conversion of section 1031 exchanged property to section 121 property. not all information. the tax law is not all inclusive. a lot of tax treatment is dependent case law, irs letters, etc. for example, there is no law that spells out exactly what is intent. paying for a professional opinion may be warranted.
    Susan Maneck Investor from Jackson, Mississippi
    Replied 3 months ago
    I bought a HUD house via FHA for 72K, but during the recession it went underwater. Rather than crying over that, I started buying up houses in the neighborhood. I ended up finding one for sale via Fannie Mae for 30K which I liked better because I got tired of climbing stairs. So I rented out my house and moved into this one three blocks away. It rents for $950 which barely covers my expenses but I’d lose a lot if I tried to sell it.
    Meghan Custer from Maryland
    Replied 3 months ago
    My family will be moving to a new home the end of this year and we are in the middle of this debate as well – can’t wait for the podcast to air.. Our dilemma is in the equity. We will need a fair amount of our current equity to use as a down payment on the new home. Any advice on the tipping point for a deal like this? When does it become a better idea to sell rather than keep and rent?
    Michael P. Lindekugel Real Estate Broker from Seattle, WA
    Replied 3 months ago
    i think your question is more about safety net than return on investment for decision analysis. if you sell your current home, then you have that equity as the down payment to acquire your next home. you could refinance your current home or take a second mortgage or HELOC to access the equity and use that as the down payment for your next home. keeping your current home may mean that it is highly leveraged. we are heading into a recession. typically, financial distressed sellers end up in that position from falling dominos of problems not just one problem. you dont want to put your new home at risk of foreclosure in a recession from problems with your rental. high vacancy. low rent. inability to pay the mortgages.