Exit Strategies - Capturing Appreciation on Primary Residence

Buying & Selling Real Estate
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Exit Strategies - Capturing Appreciation on Primary Residence

Ben Booker
Santa Clarita, CA · Member since 2017 · 6 posts · 2 votes

Hi Everyone,

Situation: Right now I am working in the San Fernando Valley (just north of Los Angeles) and living in Santa Clarita Valley (just north of San Fernando Valley). I own a 2b2b condo in Santa Clarita which I bought in 2015 for $226k. Right now, Zillow, Trulia, and Redfin have my condo estimated at $261k (the average of the three sites).

Question: The market is very hot in this area and I anticipate a market correction coming soon. I would like to capture the equity in my home before a market correction. I am anticipating only living in the Santa Clarita area for one more year (planning on moving to a market with much lower cost of living - i.e. arbitrage-ish killing on selling my appreciated Santa Clarita house in super inflated market and using that to start my first real estate investments in less inflated-more affordable market). Any recommendations on an exist strategies for capturing the appreciation an reinvesting for a short term period before I move? The options that came to mind (in order of most preferred to least) was watching the market close and not selling unless apparent that market was heading down, buying a flip that I could sell in a year if the market continued to climb, or I could gain some profit/break even if market stayed flat, or cash flow instead of flip if there was a precipitous market fall and manage from a distance. Any creative ideas that I haven't mentioned?

Let me know if you have any follow up questions.

Thank you,

P.S. No experience flipping or property management (learning and preparing though).

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Bill ExeterBusiness Member
1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
9y

Hi @Jeff B., 

The 1031 Exchange would not apply here as the property is his primary residence.  The 1031 Exchange only applies to rental, investment or business use properties.  The sale of his primary residence will actually fall under Section 121 of the Internal Revenue Code ("121 Exclusion").  He would qualify for $250,000 in tax-free gain as long as he can say that he has owned and lived in the property as his primary residence for at least a total of 24 months out of the last 60 months (based on the closing date). 

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  • Marian Smith
    Real Estate Investor · Williamson County, TX · Member since 2011 · 1k+ posts · 961 votes
    9y
    How much is your mortgage PITI, how much equity do you gain per month? and how much would it cost you monthly to rent? If you sell you typically spend 6-10% of the sales price on commission and selling costs. You may be better off waiting until you are actually moving, you never know what tomorrow brings.
    1Reply
  • Walter Roby jr
    Rental Property Investor · Encino, CA · Member since 2016 · 324 posts · 178 votes
    9y

    I agree with @Marian Smith. Your equity will get eaten up once you sell, find a new place, move etc. Not quite sure if you will be better off unless you find a solid investment to move into.

    1Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    9y

    Consider using a 1031 for the transition. Contact a qualified intermediary for the requirement (which includes buying for at least as much as you sold).  @Dave Foster

    0Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    9y

    Hi @Jeff B., 

    The 1031 Exchange would not apply here as the property is his primary residence.  The 1031 Exchange only applies to rental, investment or business use properties.  The sale of his primary residence will actually fall under Section 121 of the Internal Revenue Code ("121 Exclusion").  He would qualify for $250,000 in tax-free gain as long as he can say that he has owned and lived in the property as his primary residence for at least a total of 24 months out of the last 60 months (based on the closing date). 

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    3Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    9y

    Oops -- you are SO RIGHT - - I must not have had my coffee :sigh:

    1Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    9y

    You are not sitting on much of a gain and most of that gain will be eaten up by transaction fees. Unless you are leveraged to the hilt on the property and struggling to make ends meet, your best bet is likely to do nothing until you are ready to move. Even then, if you are moving to an area you are not already VERY familiar with and already have a RE network in place, your best bet would likely be sell or rent your Santa Clarita property and rent in the new market for 1 year to get the lay of the land, build your network, and take your time to find a great deal.

    Finally, "expensive" does not necessarily equal over valued, just as "more affordable" does not necessarily equal under valued ... this is RE valuation 101, and you should learn it a bit more before making any investments, otherwise you may end up arbitraging yourself to the poor house.

    1Reply
  • Ben Booker
    OP
    Santa Clarita, CA · Member since 2017 · 6 posts · 2 votes
    9y

    Thank you all for the replies. Dowe in San Diego for a vacation weekend, so I'll digest now and respond later. 

    0Reply
  • Jay Dimacali
    Specialist · Granada Hills, CA · Member since 2013 · 73 posts · 21 votes
    9y

    @Ben Booker  Just curious what makes you think the market it headed for a correction?

    And your equity isn't as much as you think it will be after the costs of a transaction are accounted for as someone else mentioned previously.

    1Reply
  • Ben Booker
    OP
    Santa Clarita, CA · Member since 2017 · 6 posts · 2 votes
    9y

    Hi @David Faulkner. Thanks for the advice. I definitely want to rent in the new market for a couple of months and get connected with a local RE network. Good point on being careful about definitions. I was thinking of "affordable" and "expensive" in terms of cost of living. For instance, I am an auditor (CPA), and the mean salary for the L.A. metro area is $82,780 for May 2016 and the mean salary for the Minneapolis metro area is $72,550 for May 2016 (according to the Bureau of Labor Stats). This is an approx. decrease of 12%. The mean housing prices for the same areas are $617k and $345k. This is an approx. decrease of 44%. This is the sense in which I meant less expenses/more affordable.

    On the equity note, it may not be "significant," however, I would rather the selling costs come out of the appreciation, rather than having no appreciation (or depreciation), yet still having to pay those fees.

    As far as refinancing the equity out, but keeping the CA property as a future rental, I don't think I would want to manage from a far, even though I agree that CA real estate could have great long term appreciation and consistent occupency (in my area for the foreseeable future).

    Thanks again for the replies everyone. I think I am going to hang in there for a few more months before I move. Once I move, I think I will rent for a few months and narrow down some multi-family house hack prospects.

    0Reply
  • Ben Booker
    OP
    Santa Clarita, CA · Member since 2017 · 6 posts · 2 votes
    9y

    Hi @Jay Dimacali. Good question on the market correction. Probably the biggest reason that I think my market has a market correction coming due (at least is my area) is that values have now reached/exceeded the pre-recession levels. Based on my search of the area (and inquiry with my real estate agent), there are very few houses/condos on the market compared to PYs and that scarcity is driving prices upward at a rate that does not seem probable to last more than a couple/a few years. So it makes sense to me to take my equity to another market at a time when it is good to sell in CA to a place that I'll get more value for my money.

    I agree with you, my appreciation above the cost basis is currently not "significant" and will get eaten up in transaction fees. I'll still take a little gain though, with a lot of realized equity due to excellerated mortgage payments, rather than selling later for less than I bought plus the transaction fees.

    0Reply
  • Sagar Mata
    Oakland, CA · Member since 2016 · 14 posts · 5 votes
    9y

    @Bill Exeter question for you if you don't mind: Does the 24 month rule start counting back from the closing date? 

    I just bought a new primary residence (hasn't closed yet) and deciding wether to rent the existing PR or sell. If I close on the new one and rent the old one for even a month, do I negate the 250k/500k tax credit or is there a bit of a grace period?

    0Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    9y

    @Sagar Mata, the "look back" window to see if you qualify for the 121 primary residence exemption is 5 years backward from the date of the closing of the sale.  If you closed on the sale of your residence 7/1/17 and have lived in the property for 24 of the 60 months from 7/1/12 to 7/1/17  then you qualify for the exemption.  

    So if you move out after living in the house for the past 2 years you can still rent it for 3 more years (be very careful of the date of your sale so the 5 year look back doesn't trip you up) and still get the full 121 exemption.  In that event you would also have to recapture depreciation from the 3 years used as a rental

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  • Sagar Mata
    Oakland, CA · Member since 2016 · 14 posts · 5 votes
    9y

    @Dave Foster that's exactly what I wanted to know! Many thanks for your help.

    0Reply
  • Bill ExeterBusiness Member
    1031 Exchange Qualified Intermediary · San Diego, CA · Member since 2008 · 1k+ posts · 1k+ votes
    9y

    Hi @Sagar Mata, 

    Yes, you look back 60 months from the date that the sale of your primary residence closes and as long as you can say that you have lived in the property as your primary residence for at least a total of 24 months out of the last 60 months you will qualify for the 121 Exclusion. 

    You will have a three (3) year window from the date that you actually moved out of your old primary residence to sell and close on the sale in order to still qualify for the 121 Exclusion, and after the three (3) year window you would no longer qualify for a 121 Exclusion but you could structure a 1031 Exchange transaction. 

    One of the most important criteria when deciding what to do is that the 121 Exclusion is tax-free and the 1031 Exchange is tax-deferred.  The 1031 Exchange can be tax-free, but you have to exchange until you die in order to become tax-free (stepped up cost basis at date of death). 

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  • Sagar Mata
    Oakland, CA · Member since 2016 · 14 posts · 5 votes
    9y

    Thank you again @Bill Exeter and @Dave Foster. This is extremely helpful.

    0Reply
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