I have been browsing the forums for a bit now after discovering the Bigger Pockets Podcast a while back. What a great resource! I am hoping you all could chime in on this one:
My personal residence (and our first home) was purchase a few years ago at a great price and now has $100k in equity and total value of $240k. We would like to move into something with more land and I cant decide if we should keep our first house which I could sell with no capital gains, or keep and have about $500 in cash flow as a rental. The thought of loosing out on the primary residence tax exemption makes me cringe.
Is there some simple math that would make our decision easier? Thank you for your guidance!
Specialist · Milford, ME · Member since 2016 · 630 posts · 378 votes
7y
100k divided by $500 a month is almost 17 yrs. Do you need the money now or do you want to spread it out? Is this going to be your only rental and if so is it going to be worth the hassle?
Specialist · Milford, ME · Member since 2016 · 630 posts · 378 votes
7y
100k divided by $500 a month is almost 17 yrs. Do you need the money now or do you want to spread it out? Is this going to be your only rental and if so is it going to be worth the hassle?
There is good news, you can likely turn the property to a rental for 3 years and still be eligible for the section 121 exclusion($250,000 of capital gain or $500,000 if married filing jointly). You would only be subject to depreciation recapture based on the depreciation taken during the period it was used as a rental.
Have you looked into doing a cash-out refinance before turning it into a rental? this will allow you to pull out the equity.
100k divided by $500 a month is almost 17 yrs. Do you need the money now or do you want to spread it out? Is this going to be your only rental and if so is it going to be worth the hassle?
This would become my first rental. It should not be too big a hassle since the home is in good shape and I am not moving far from it. I do not need the money now; just trying to make the best use of my money.
There is good news, you can likely turn the property to a rental for 3 years and still be eligible for the section 121 exclusion($250,000 of capital gain or $500,000 if married filing jointly). You would only be subject to depreciation recapture based on the depreciation taken during the period it was used as a rental
Have you looked into doing a cash-out refinance before turning it into a rental? this will allow you to pull out the equity.
A refi seems like a good idea if I were to keep it as a rental long term.
Rental Property Investor · Fort Collins, CO · Member since 2015 · 128 posts · 327 votes
7y
@Brent Perkins You are where I was when I started investing in real estate. I did a cash out refi and then retained the house as a rental, and I still believe in that decision.
At the end of the day, it comes down to opportunity cost. If you sold that house and took the cash, what would you do with it. Invest it? Invest it how?
If you believe that the stock market is a better place for your money than real estate investing is, then go for it. You won't find much of that opinion on this website, but that's your prerogative. You won't have $100k to invest, though. Selling a house costs you about 6% of its value in agent commissions. For a $240k house, that's ~$15k lost forever.
But if you believe in real estate as an investment, then you need to understand that transaction costs are huge in real estate. Selling will cost you that $15k, and buying costs you a good $5k in closing costs. In other words, if you sell your house and use the money to buy a different house as an investment, your transaction costs will take a huge bite out of your money!
Far better is to choose a different tax-free option: not selling. Obtain your first investment property without the costs of an extra sale OR an extra purchase - just repurpose the house you're moving out of! You'll have some combination of monthly cash flow, mortgage principal payments, and house appreciation all adding to your net worth. The rate of return on your equity is usually far larger than you could expect to earn investing that money in other ways.
In fact, many investors deliberately move every few years just so they can purchase using friendly owner-occupant mortgages, improve the property while occupying, and add to their portfolio by moving out.
Now, what about selling? Won't that big tax bill come eventually? Not necessarily. You can use cash-out refinances to extract more equity forever. Why ever sell, as long as the investment is worth it? Own 'til you die!
None of this means you get out of having to do market analysis, though. It may be that your current residence makes a uniquely terrible rental. Your suggested $500/month cash flow sounds good, but that's pre-refinance. I also have no idea whether you ran your numbers correctly, or whether your neighborhood is growing or dying.
What I am saying is that the fact that you already own it is a huge benefit vs having to buy to invest.
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