1031 or cash out refi?

15 Replies

Hi bought a personal residence condo in 2009 for 480K in Southern California. The area has improved. It's been rented out the past 7 years, minus a 9 month personal-residence stint where I refi'd to a great rate (3.62%).  I only owe 270K now. The condo should be worth about 620K now and I would like to buy a place to live in (immediately or eventually). So I am wondering: 1-should I cash out refi and take a higher interest rate to have cash in hand for another down payment? OR 2-Should I sell the property, take the $ and buy another place as a 1031 exchange and then move into it in a few years? 

I'm not in a rush to buy but do want to maximize the equity and get something nice I would want to live in myself eventually. I don't want to go back to that condo because the neighborhood is nice but not close to my industry.

What is the best move, long-term? 

@Mary Gold sounds like a good position to be in!

Ok, first I would more accurately define both of those options.

1 - Cash Out Refi: explore the rate you would be getting right now. How much higher is it? What would that do to your monthly payment? Will the rent cover all of that and more? Will you have to adjust any numbers to contribute the same amount of cash flow & savings to monthly reserves on the property? I have a feeling once you really see the monthly net effect on your income/savings, that will give you a better idea of where you want to go.

2 - 1031 Exchange: these I do not have much experience in so I suggest consulting with an expert in the field. The whole "like-kind" criteria surrounding the exchanges may make going from an Investment rental property to a Primary residence property difficult. I have not found a definitive answer to that but perhaps you can in a consultation. Another consideration for the 1031 is actually finding the property you want in the given time frame you need to meet the exchanges requirements (45 days after closing on sale of property, you must ID up to 3 potential properties to use for exchange. Then another 180 days after the close on sale of your property, you must close on the exchanged property you ID). While that sounds like a lot of time, inventory is low and demand is high so keep that in mind when scheduling your time frame for everything.

Certainly you're aware of the tax advantages/disadvantages at this point but I think it is important to really see the amount of money you'll save/spend/lose in each option first. Best of luck!

@Mary Gold

Hi Mary,

First off, welcome to Bigger Pockets and congrats on your first post. 

Second, I think you have to think of your personal income and speak with a reputable accountant to make sure that whatever suggestion you get from anyone on here, that it does not effect you negatively in your specific circumstance. 

BUT, with that being said there are a few things to consider and a possible third option. 

A. If you buy another personal residence, what price range are you looking at? (i.e will you exceed the total amount of the $750,000 mortgage deductible for a personal residence, becasue that would negatively effect you in our new tax code)

B. If you refinance, what rate will you get, and how does that play out over the loan? Also assuming you will be moving into an investment vs a personal residence your rate will be up quite a bit

C. I would also talk to a 1031 profesional on transfering the asset becasue you currently have it as a "personal residence" the taxes may not be as bad as you think, and/or if you are a joint filier you have additional benefits to the profit of that sale

Anyways, Im not sure this will help, but based on the information, these should be a few questions you may want to ask or look further into.

@Alexander Zurn , I think @Mary Gold , has the right idea.  "Like kind" for 1031 purposes is any kind of investment real estate for any other kind of investment real estate.  What she would be doing is selling an investment property and buying an investment property and then later in a couple of years possibly converting that property into her primary residence.  Nothing wrong with that.  There's even a 2 year safe harbor from the IRS with some other stipulations.

The only thing I can think of that might push the balance either way is that if you 1031 you'll have to be getting investment financing on the new property which might not be as advantageous as you would like.  And then after two years you're stuck either with a higher interest rate than you want or a second refinance into owner occupied.

On the other hand though if you refi  you have access to less cash.  You can get an owner occupied interest rate from the get go.  You don't have to use it as investment for 2 years before moving in.  But... you're still stuck with the investment property and must decide whether to later sell and take the profit taxable.  Or do a 1031 into another investment property which might stretch you if your plan doesn't include holding investment real estate for life.

Thanks to you all! Great points by each of you. Great point about the 750K limit and the new tax code, Nabil. And Alexander, definitely worth looking at real numbers. You're right. 

I think @Dave Foster understood my conundrum most closely and gave me the most relatable response. I'll be talking to a professional financial advisor as I think I would like to explore selling and getting a multi-unit if possible. So a combo owner/investment possibility. 

@Dave Foster @Nabil Suleiman @Alexander Zurn I got some numbers crunched (by a mortgage professional, so his best interest is in me getting TWO loans from him of course).

The scenario is now:

-Refi cashout at a new interest rate of up to 5.6% (vs my current 3.6%). YIKES!!! Take $130K out. This would make my all-in expenses on the rental about $150 more than what it's currently renting for. 

-I would take the $130K and buy a personal residence, up to $750K (maybe for the tax shelter situation), but ideally, I guess I would have a $650K limit given I would want to put 20% down. 

-My current rent is $2600 for my personal residence, and will definitely rise, come April.

I guess my real question is:

1-Should I keep this investment property? 

Pros: 

  • Good interest rate
  • high-demand area
  • already at $1000 cash flow. 

Cons: 

  • There are some builder flaws. But I hear those happen anywhere. 
  • I pay a manager to collect the rent. He's a shmuck but I could just terminate him. 
  • The annual income from this property is only about 7.7% (compared to purchase price) now. And it will be a negative if I refi with a higher interest rate and a bigger loan. 

2-Should I just sell the investment and take the capital gains hit and buy me something at a lower interest rate? (I can always buy a rental unit somewhere, with the full intention of making it a rental from the start vs the one I currently have  as a rental, which started as a personal residence)

3-Should I leave the investment condo, and just sell my stocks for a down payment on a new home for me, (and make sure I don't exceed the $750K limit for the tax deductibility)? 

What would you experts do??? I hope it doesn't sound like I'm at square one because now I have some #s. 

Hi Mary @Mary Gold

Glad you are doing well and researching your options deeper. 

1. How much cash flow do your stocks bring you? The nice thing about your current situation with your rental is that you know you are getting 1,000 a month. If selling your stocks is a better financial option then you should explore that deeper. PS if you don't like your manager you should interview others, there are so many around LA. 

2. Seems like you got it at a good time at a good interest rate. If you are cash flowing 1,000 a month in LA, it would be pretty difficult to find something similar in our area in our current market. If it doesn't hurt you to keep it, and you don't have a better deal to put the money into right now.. I would keep it. (my opinion)

3. the 750k is not the price of the house, its the amount on the loan. so you could buy a 1m dollar house if you had 250k to put down. and if it was 780 vs 750 the impact isn't that significant. Just remember your condo is still considered a personal residence, so you would want to talk to your tax professional on the likelihood of both impacting the write-off. 

anyways, I hope this helps. Good Luck, and feel free to reach out anytime. 

@Nabil Suleiman thanks for the questions.  Here are some answers/comments:

  • How much cash flow do your stocks bring you?  Um... It's volatile. I am up, but I never take the $ out. I just let it sit. So really, I don't know. 
  • Yes, me too. I'm leaning towards keeping the condo as-is. I can't get a 3.6% interest rate again! And $1K is good cash flow. :)
  • Oh thanks for clarifying that the $750 is the size of the mortgage that could be tax deductible with the new tax codes. I'd probably wanna stay under the jumbo loan limit anyway though, so I'd likely have to take a loan less than 680 (or whatever the limit is these days in Cali). I'm not sure which would apply to me: "limit is $453,100 nationwide, with extended limits of up to $679,650."
  • My investment property is declared on taxes as an investment already so I doubt it's considered a personal residence anywhere. So I'm already paying whatever taxes on the income and factoring in depreciation.

Thanks again. Seems I may sit tight. I just have this urge to "nest" and buy a place so it's mine and I feel like I'm setting roots again. But hey... renting is pretty head-ache free, other than the annual rent hike-ups. 

@Mary Gold

Awesome. 

- I would explore the stocks deeper as an option you can utilize when you decide to make the move. 

- The condo deal seems like a great one to keep the way it is. 

- you are correct on the jumbo loan size (rounded up a few hundred) 

- Great so then you already have the answer for that, done and done. 

You are doing great. Keep it up!

@Mary Gold , There's so many gaps and necessary info to give you good guidance that any counsel you get from these posts is only going to be reflections on individual bias as it relates to a real estate investing philosophy.

Any of your scenarios could be the right one or the wrong one depending on the fact set.

Chief among the unanswered questions is what is your cost of living now.  

1. A cash out refi buys you a new primary but at what cost to your cash flow.  

2. A sale and payment of California and federal capital gains after 7 years of appreciation and depreciation is going to be a heck uv a tax.

3. A 1031 gets you a new primary without paying tax but slows you down moving into it for a year or two.  And When you finally do sell you will still have to recapture depreciation and you will only get a portion of the gain tax free.  Of course if you never sell you never pay the tax.

The only take away advice I'd give is to stop thinking about interest rate.  The interest rate you get is irrelevant.  It's the impact on your financial picture partially caused by the interest rate that is important.  Many folks make money paying relatively high interest.  And thousands of folks with fantastic interest rates lost their shorts in 2008.

Thanks @Dave Foster . Makes sense. That's what the mortgage lender told me. He said to ignore the %s, bc in real estate, I should be focusing on the value.

To answer your questions: 

  • If I refi-cash out to buy another property, my cash flow would go from a very nice positive to a slight negative. But it would likely even out very soon. The neighborhood is hot and I could afford the extra couple of hundred bucks to keep the place. 
  • Yes, I don't want to sell without a 1031 due to all the taxes. So I'm actually contemplating a multi-unit as another option still! Just don't know how much downpayment I would need (20%? 30%? more?) for that and whether I can live in one of the units, even though it's a 1031. (I posted a fresh new question in the 1031 category just now.) If you have input on that, please let me know. 
  • My current cost of living is not strenuous. I have enough to live comfortably enough now. If I refi-cashout and buy another place, I will not have as much disposable income but I'm okay to live with that. The cash situation wouldn't feel like a huge impact bc my current rent is not exactly cheap.

Thanks for your help.

@Mary Gold , you can actually have the best of both worlds here. Why not get a HELOC on your condo? By your numbers, you should be able to pull out around $300k, you don't have to pay any interest on it until you actually use it, unlike a cash out refi, and it would give you a healthy down payment on a new property. This strategy has worked wonders for me. Best of luck!

Hi @Corby Goade I'm afraid of the volatile interest rates I would face with a HELOC. That uncertainty makes the situation unattractive for me. Pls tell me if I'm missing something here. Thank you!

Good Morning @Mary Gold , understandably so. You aren't missing anything specifically related to a HELOC, but you are missing out on the strategy. The goal in this process (BRRRR- search for it here on BP if you are unfamiliar), is to use your HELOC as leverage and convert it in to a locked rate mortgage as soon as possible. I've done this several times and it's been a game changer for me. Depending on your deal and the financing, you can do this in some situations immediately after closing. Happy to go in to more detail if you'd like- you are welcome to PM me.

@Corby Goade Ah... That sounds smart. I called BOFA and they don't do HELOCs on investment properties apparently?! I guess I could find another lender. I don't know if I have the gumption to do the BRRRR. But that sounds like what I should be doing.

----

Hi all, 

Instead of all this $ maneuvering, I'm now facing another decision: 

A buyer who tried to buy my neighbor's condo and got outbid with a cash offer is interesting in buying mine. My unit just appraised for 640 but he's saying (so far) he will want to pay below 630, since that was the end price on the unit he was initially interested in, and that one was "nicer" (staged vs mine with 3 dude renters). 

So--- if I do sell, I can potentially put down payments on 2 investment properties! 1-in an area I would want to live in 2 years and 2) in an "up and coming area" where I could live in 10-15 years. This way I will have 2 investment properties, and in areas I would rather live in eventually. 

Am I just caught up in a selling frenzy and seeing dollar signs when I should really be hanging on to my awesome investment with a low interest rate?  Should I just go for a home equity loan and buy a 2nd personal property and call it a day? 

Scenario 1- I don't sell. I keep my low interest rate. I take out a 2nd mortgage (home equity) and buy a personal property at a normal interest rate.

Scenario 2-I do sell. I take the $ and buy TWO investment properties that will require 2 investment loan interest rates (5+%) but I will have properties in more personally-pleasing areas. (I have a feeling you all will say it doesn't matter how much I like the area... it depends if it's making $ as an investment to consider this a true investment)

Any thoughts are welcome. I know I've already presented a ton of scenarios and may be overstepping the question quota on this thread!

Thanks.

HI Mary- there aren't many banks that do HELOCs on non-owner occupied properties, but they are out there. It will take some work, but nothing worth having comes without effort! Best of luck.

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