What's the best thing to do, Rent or Sell our Home?

18 Replies

We're at a crossroads of what to do and seek advise from experts both in the investing and financial areas. Here's our situation...

Our Home is worth $450K (according to comps provided by our RE agent). We own the house free and clear. Taxes are out of this world where we live at $9,000 per year. We want to take out a loan to cash out some of our equity (say 50%) but we can't get qualified with the incredibly tight lending laws these days due to our self employment income not being high enough even though we get over $4,000 monthly on top of our self employment from my wife's dad's retirement fund but can't be used in Texas as income because she's POA and POA money can't be used (Power of Attorney).

So we decided that maybe (with our daughter graduating HS in May) that we should instead sell our house and downsize from 3750 sq.ft. home to 2200 - 2800 sq.ft. home out of our city and cut taxes in half and cash out to fund our RE investments.

Then we thought that maybe we can cash out instead one of her dad's annuities (valued $311,000) and buy a new home with that and instead lease our home (high lease area due to the top level schools in all of Dallas county). We can get about $3,000 to $3,200 per month in lease which after taxes and insurance is $2,000 to $2,400 income monthly.

However, not sure what the tax hit is on cashing out the $311K from her dad's annuity but thought that we can use the IRS form 709 gift tax form to limit the taxes and take the gift and pay for a new home which may or may not affect taxes. We're calling our CPA Monday to ask but thought I would ask here since there are so many RE and professional people here.

If we purchased a home and leased our house, that would be our second leased home on our portfolio and move the income from his income to our income which could help us get qualified down the road. Depending on the price of the home we get and any updates we want to do, this might limit us to any cash out but would increase our monthly income to help pay for our daughter's college in the fall.

OR we sell our home and cash out about $120K - $150K and use that to finance a fix and flip home (maybe with some private money or hard money help). Tough decisions. What would you suggest or in our shoes do?

Are you familiar with the $500,000 home sale tax exclusion?  That would lean me toward the sell direction especially if you're thinking of downsizing and want to leave that high property tax area.  You'd then have money to buy a smaller house, pay for the kid's school, and invest in real estate.  With that kind of money you should be thinking about investing with a syndication in apartments, not single family homes.  Renting out a high end home like you have may be a pain because the renters are going to expect everything in the house to be perfect.  Flipping doesn't sound like fun to me since you'd be taking on another job.    

@Rodney Marcantel

You didn't indicate your basis in the property so the income tax exclusion for selling your principal residence may or may not be a big deal

Saying that, I would still lean toward selling the property as the $2000-2400 cash flow you indicated can easily be replaced for much less than $400,000

I am also answering this from the perspective that your personal residence is not personal however your wife and family may feel otherwise ! :)

The $2,000 - $2,400 is after taxes and insurance to hold the home. If we sell, we will have to pay about $26,000 in RE fees. @Greg H. our home is personal residence. We own outright. My wife and I are looking at both angles between selling and leasing so we're on the same page.

The home we want is new construction in an area we really want to move to that's not far from where we currently live and not far from our other rental where her father lives. Price on the new home to be built is $355K with extras to customize for us.

So $450K sell price (if we get that) - $26K - $355K for new house = $69K left over give or take $3K - $5K. 

Leasing home would put us tax and insurance wise for 2 rentals and our new home would be $1,850 monthly. Bringing in $3,000 monthly on our lease would leave $1,150 in profit monthly. We could use that to pay monthly for our daughter's college.

@Rodney Marcantel if you own the home outright, by not selling, your $450k will generate $2-3k per month. Assuming there are absolutely no expenses and you keep every penny of the income (which doesn't happen) the $450k would generate between a 5.3 and 8% return. For me, that's not good enough to justify additional risks associated with real estate investing (mainly liquidity).

If you want to generate high returns, you will want to use leverage and purchase several properties or one larger multi-family. I look for, at a minimum, a 12% annual return.

I can see why this is a tough decision for you; you have many ideas swirling around. Sounds like the new house is the right choice for your family but I'm surprised as a REI you don't want to leverage it at least a little. You haven't mentioned your credit and I understand that lending is "tight" but it seems like you should be able to get some kind of loan, even if its not from Wells or BOA, with a little more money than the standard 20% down. That would leave lots of extra cash to invest, pay for school and do the upgrades on the new house. I mean, why create a bunch of "dead equity?" Especially with record low interest rates.

Its a little tough for me to follow your ROI numbers but on roughly 320k, it seems like a very low return with the above plan.

Banks have turned us down because our Debt to Income ratio isn't good relative to our self employment income which is about $1,600 monthly plus $2,000 monthly on our one rental we own now. However, the banks use a formula that limits the income on a rental to $2,000 *0.75 - $350 (taxes and insurance). Or $1,150 in income from the rental. That puts us at $2,750 in monthly income. But we get an additional $5,000 monthly from her dad's retirement funds valued at just over $1,000,000. However, we can' touch that without paying taxes on it until he passes away.

With that said, we think the best thing to do is sell the house and use what's left to fund real estate with the help of a private lender or hard money. But that $2,750 that banks count as income would require us to have a debt of under $1,000 to hit their 35% debt to income ratio for qualification on a loan against our new home.

@Rodney Marcantel

 - You mentioned that you can't get a loan on a $450k house that is totally paid off because you are self employed.

What bank are you discussing the loan with?  Is it a large national bank; Wells Fargo, Bank of America, etc?  Are you trying to get a secondary market loan; Fannie or Freddie Mac?

The reason I ask is that if you have decent credit, tax returns to support your self employment income for the last 2 years, you should have no problem getting a smaller bank to make you an "in-house" aka "portfolio loan" against the equity of your house. These are loans that the bank actually holds and services until you pay it off. The secondary market loans are loans that the bank immediately sell off to be packaged and sold as bonds. They are much stricter and harder to get for a self employed individual. A local bank should easily give you 75% LTV (Loan to Value) or $338,000. If you are only wanting 50% LTV or $225, smaller banks will be drooling to get this loan. (Assuming you have pretty good credit, and your tax returns are evidencing your self employment income.) Good luck!

I just saw your post that you mention your debt to income ratio over.  I didn't see that when I type my above post.  Sorry. ;(  

Yes, that will stop them from lending to you whether it's a portfolio loan or secondary market loan. You'll need to be able to evidence more income on your tax return to get over the debt to income ratio hurdle. 

I think you still have options here.  Could you show more income by taking dad's retirement fund and pay the taxes until you get a loan then stop withdrawing?  Who cares if you pay a little tax.  Seems like you need the money now, not when he dies because that could be in another 10-20 years.

I bet you have tons of dead equity in that other rental.  You could sell that as well since you probably can't pull any equity out of it and the proceeds would help pay for school, upgrades to the new home and other investments. 

Option 3: How about selling your primary and renting in the neighborhood of your choosing for a few years?  It would allow the money you invest to mature and really start pumping out cash flow as opposed to tying it up in a home.  Did you know that if you're a passive investor in an apartment you won't have to qualify for the loan? 

I know option 3 seems like its in left field but I once asked a millionaire why he told me to not pay off my house meanwhile he paid off his house.  He said, "do you have all the passive income you want?"  I said, "no."  Then he answered, "well, I do, so that's why I can afford to pay stuff off and you can't; unless you want to try and get rich slow, you need to invest any extra income you have."  And that's how I learned about "dead equity."    

  

We currently use the $311K that we get $15K annually around November to pay the taxes and insurance on both our home ($450K value) and our rental ($225K value) that my father in law lives in and is on the Title with us so he can get homestead exemption and over 65 exemption on property taxes. So selling his home (our rental to the care home organization) is not an option.

One other choice is to go ahead and sell our $450K home, get the new $355K home (brand new) and use the balance to pay for our daughter's college. Maybe we can have better luck securing a new mortgage on that home than trying to get a cash out refi that we were only asking for 50% LTV on. We would then pay cash for 50% of the new home and try to finance the rest which would give us $270K - RE fees on existing home ($26K). The trick is to find a lending institution that will give us a 4 - 5% mortgage.

I do like the idea of cashing out the $311K from his annuity and banking it minus the tax hit but we do use that $15k we get annually to cover our tax and insurance burden on both houses. If we sell our house, the tax burden on the new house will be about $4,000 less. Although we could put the $311K to work in our RE business and likely turn higher profits than the $15K we get and still be able to pay our taxes and insurance which would lower to $11K annually.

Ok. Spoke with our CPA and he suggests that we move the $311K from the annuity that's earning 3.5% to her dad's retirement fund accounts and set it up as a Self Directed IRA that we can use for house flipping. That will avoid taxes if we roll it over which could save us over $60K in taxes (taxed at 33%) if we were to instead take the money out.

With the Self Directed IRA, we can draw from it for flipping and pay back on monthly schedule. Profit would be taxable unless put back in the IRA. So we're meeting with our fund manager on Wednesday and he will let us know what we can and can't do to roll this over to a Self Directed IRA.

On the House Front, our RE agent is wanting to list for $460K and the home we purchase will be around $380K. So minus $20K (our RE agent is giving us a break on her fees) will leave us about $60K to cover our daughter's college. One other option is to take the $440K (minus the RE commissions) and only put down on the new house 45% would give us a mortgage $209K (over $200K to get below 4% interest rate) and have $269K to use for investing (not including tax implications which is another area to explore).

@Rodney Marcantel

It would seem you have a mis-understanding of how a self directed IRA functions. There is no allowable mechanism whereby you draw from the account and repay on a monthly schedule. IRA's do not allow for loans to the account holder.

You simply cannot use IRA funds to flip houses in your own name.

If the IRA capital is being used to flip houses, all returns go to the IRA and gains from that type of trade or business activity are subject to UBTI taxation. Passive gains from lending or collecting rents are not taxed in this manner.

The idea of investing that capital differently get get better income is fantastic, but it will need to remain within the IRA until such time as it is being taken as a taxable distribution.

I'd suggest you continue to research this field by speaking with a professional who really understands self directed IRA plans and rules.

Originally posted by @Rodney Marcantel :

Ok. Spoke with our CPA and he suggests that we move the $311K from the annuity that's earning 3.5% to her dad's retirement fund accounts and set it up as a Self Directed IRA that we can use for house flipping. That will avoid taxes if we roll it over which could save us over $60K in taxes (taxed at 33%) if we were to instead take the money out.

With the Self Directed IRA, we can draw from it for flipping and pay back on monthly schedule. Profit would be taxable unless put back in the IRA. So we're meeting with our fund manager on Wednesday and he will let us know what we can and can't do to roll this over to a Self Directed IRA.

On the House Front, our RE agent is wanting to list for $460K and the home we purchase will be around $380K. So minus $20K (our RE agent is giving us a break on her fees) will leave us about $60K to cover our daughter's college. One other option is to take the $440K (minus the RE commissions) and only put down on the new house 45% would give us a mortgage $209K (over $200K to get below 4% interest rate) and have $269K to use for investing (not including tax implications which is another area to explore).

 Hey Rodney,

Definitely speak with a tax professional who is knowledgeable regarding retirement accounts. I can't believe that in 2015 professionals in certain fields are still giving bad advice on such basic rules, but you're certainly not alone in getting bad advice. 

There is no way to flip houses with qualified funds in your name, you can use the retirement funds to invest and flip real estate, but you can not provide services to those properties including "sweat equity". Basically the IRS requires that your qualified accounts be treated as a separate legal entity that you are prohibited from doing business with as an individual. 

There is no way to take a loan or "draw from and pay back" an IRA, money out of an IRA will be subject to tax and possibly penalties, unless directly transferred to another custodian. You may be able to avoid the penalty if the funds will be used for higher education or the purchase of a first home, but you should speak to a tax advisor. The only way a loan would be possible is through a 401k, which is capped at $50,000/50% vested balance.

Adam

That's why we're meeting with our investment adviser tomorrow. The money is in her dad's retirement account which she is POA and he has severe Alzheimer's. I know you can use Self Directed IRA's to fund real estate as it's an investment tool to growing retirement income. Only question is what tax hit is there if profits from that are taken out versus putting back in the IRA.

This is just my thoughts on the topic since I have property in Dallas Fort Worth area. I would seriously look at selling it because of the taxes. I am not sure if your home is already homesteaded but when i converted my home into a rental my taxes went up about 47 percent. If you havent figured that into the investment equation, it will absolutely desolate your rental income. 

Just my two cents. 

Check out Solo 401k's, they're far more powerful than any other retirement vehicle I've seen.   You and your spouse can each borrow up to $50K from them, and can make investments in leveraged investments w/o being subjected to UBIT/UBLT.    We're using Sense Financial, and so far, so good.

Originally posted by @Rodney Marcantel :

That's why we're meeting with our investment adviser tomorrow. The money is in her dad's retirement account which she is POA and he has severe Alzheimer's. I know you can use Self Directed IRA's to fund real estate as it's an investment tool to growing retirement income. Only question is what tax hit is there if profits from that are taken out versus putting back in the IRA.

 Hey Rodney,

Essentially as long as you structure the income as distributions from the retirement account, you will usually pay tax @ your normal income rate plus a 10% penalty if you are under 59 1/2. So you can see why most people would recommend against using those funds, additionally those funds are included as income so depending on how much you take over the course of the year, it could actually move you up a tax bracket which is never a fun scenario.

Adam

@Adam Hershman, thanks for the feedback. What if the money taken out (since it's in her dad's name) is used? He's 80. So the 10% tax penalty wouldn't apply since it would be reported on his taxes. Profit would be taken out for us so that's where it's confusing to me.

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