Rent or sell primary residence?

Question

Hi folks. I Recently purchased some land from a relative ($35,000 with fair market value being in the $175,000-$200,00 range) which is the only reason I'm Going to be building based on the equity in the land. My question is do I keep my primary residence and rent it out, or just sell it and be done with it? I have a 20 year mortgage at 3.25% with about 15 years left on it. Mortage is $1600 a month with rent being in the $2500-$2800 range. If I sold I would have about $190,000 in equity from the house. If I keep the property my mortage would be about $3600 vs $2500 if I sold the property which is a substantial difference.

Ashish Acharya · Answer

Hey Danny, I agree with everything that's been said here so far. The best route really is whatever works best for your financial situation and your overall future goals, but honestly, I don't think you can go wrong either way. But from a tax perspective, if you sell now while it still qualifies as your primary residence, you may be eligible for the Section 121 exclusion, which can exclude up to $250k of gain tax-free, or $500k if married.

Bill is right, too. Definitely make sure a CPA is involved to make sure everything is documented correctly with the sale and the land purchase.

On the rental side, the big thing is making sure everything is working in your favor, tax-wise. As a landlord, you can write off things like mortgage interest, property taxes, insurance, repairs, maintenance, and depreciation, that last one is a big one a lot of people sleep on. Those deductions can go a long way toward offsetting that rental income.

And if you're interested in real estate investing, which, if you're on here, you probably are, this is actually a really great way to get your portfolio started since you already have that interest rate locked in. You definitely don't see that anymore. One thing you might want to dig into a little more as you grow is the difference between passive and non-passive strategies. Most rental income is considered passive, meaning that any losses can only be offset against other passive income. But if you or your spouse can qualify as a Real Estate Professional (basically logging 750+ hours a year in real estate), those losses can offset your W-2 or business income too, which can be a massive tax advantage depending on what else you have going on. Short-term rentals are another angle, they're treated differently than long-term rentals from a tax standpoint and can open up similar benefits without needing the full REP status.

Like I said, the best decision depends on your future goals and if you really want to start investing, this is actually a great place to start. Worth having a CPA who actually works with real estate investors look at both scenarios before you decide. The numbers might surprise you. Best of luck and happy to connect!

JD Martin · Answer

There's no right or wrong answer here but I start seriously considering selling if I'm talking about realizing 15 or more years of total rental income right now. For easy numbers, example: I have a house that nets 10k per year in rent. That's $120k in 10 years or $180k in 15 years. If I can sell it and net more than $180k (inclusive of taxes) I would probably sell. Exceptions might be if the house was rapidly appreciating in either rent collection or market value or both, or if I had no good use for the money otherwise. As I age out my window is going to get smaller, but you get the idea.

In your case lets use $2600 monthly rent, that's $1k a month before your expenses (assuming taxes & insurance are already in your mortgage payment) or $12k gross, so let's give you the benefit of the doubt and say $9k net on a good condition house that never goes vacant. 10 years is $90k, 20 years is $180k. Because it's your primary you're going to net over 20 years of income tax-free in one shot. So I would sell.

Dave Foster · Answer

@Danny Stern, I agree with what @JD Martin. There are market and personal financial factors that can influence your decision to keep or sell. If you have lived in the property for two out of the previous five years, you could take the first $250k ($500k if married) of the gain tax-free with the primary residence exclusion.

If you decide to rent out the property and see how it performs as a rental, you would still have three years to take advantage of the primary exclusion if you do qualify and still choose to sell the property. Or if you dont qualify for the primary exclusion or decide to pass it up, because it performs well, you could always do a 1031 exchange and defer all of the tax since it was converted to an investment.

You're in a position to strategize and do what makes the most sense for your financial future.

Bill B. · Answer

1) Have your relative talk to their CPA. Let’s say they paid $35k and it appreciated to $190k market value. Not sure the IRS will be happy not getting their cut of that $155k.  (Imagine I had a $155k gain on some stock and I sold it to my brother for $35k, it’s the same story, it’s a taxable capital gain they’re trying to avoid.) They may just have to declare it as a gift? If they do, you will be liable for taxes on that $155k in the future if you sell.  Luckily if you build your primwry on it you MIGHT get away with it? Maybe? Talk to your CPA.

2) How much gain do you have in your primary? It can currently be sold tax free and your rental income will have to make up for all those taxes before it makes you $1. Would you buy your current primary as a rental? If not, obviously you sell. If so, you could sell and buy the house across the street and rent it out, locking in your tax free gain.

3)Whatever your interest rate will be on any borrowed money to build your new home is, that’s your guaranteed return from selling. If you can’t double that PLUS make up the capital gains taxes you’ll be forced to pay within 5 years with 80% of the rent you’ll expect.  (To make up for vacancy, repair, capex, etc etc.) Then sell. Especially if the current house meant anything to you and it will bother you to see it beat up in a year.

Good luck. But don’t let the fact that I or many other members would rent it you make you think it’s a good idea for you. I would have purchased my primary with the plan of moving in a year or two and renting it out. So the land wouldn’t have been the deciding factor. Don’t do this because of the land.

Caleb Brown · Answer

I don't think you can go wrong either way. If you want or need the equity I'd sell. If you don't I would hold. Have you explored doing some sort of refinance into a 30 year? Might be able to pull money out while cash flowing.