Potentially selling a property advice on using profit to pay off

5 Replies

Just looking for a bit of advice as I have found some really intelligent answers in this forum before.   I have a house in San Jose, California that I am contemplating selling and need to figure out the best use of the profit from the house.  I would have about 500,000 in equity if I sell the property.

So currently I make 1200 per month by renting out the San Jose property, which I am told is not a great return since I have 500,000 in equity.

I currently have 8 rental properties actually 6 but two triplexes I just purchased will close next week

1.  First duplex is all paid off   net 1200 per month

2. 2nd Duplex is almost paid off  I owe 35,000  and will net 1400 per month

3. 3rd Duplex I owe 100,000 and am positive 400 per month  When paid  off it will net 1300 per month

4. 4th Duplex I owe  100,000 and am positive 400 per month  when paid off will net 1300 per month

5. 5th duplex I owe   100,000 and am positive 400 per month when paid off will net 1300 per month

6. 6th duplex I owe 120,000 and am positive 400 per month when paid off will net 1400 per month

7 7th triplex  I owe 170,000 and am positive 400 per month when paid of will net    1700 per month

8  8th triplex I owe 170,000 and am positive 400 per month when paid off will net 1700 per month.

Currently with San Jose property rental  at 1200 per month + the first paid off duplex netting 1200  and the other 7 properties rough yielding 400 per month for a total of 2800 per month for a total per month profit of 5200   this is an average and fluctuates if I have a major issue at a duplex.        

My Question would it be better to sell the San Jose House and take the 500,000 profit and just pay off 5 of the duplexes?   

1. duplex paid off  1200

2 duplex paid off 1400

3 duplex paid off  1300

4 duplex paid off 1300

5 duplex paid off  1300

6 duplex paid off 1400

7  400 cash flow

8  400 cash flow

My new cash flow would be 8700   compared to the 5200 by not selling the San Jose Property  so plus 3500 per month if I sold it.    The last question is how much do I get dinged on taxes when I sell a house.  I was living in it for 5 years and rented it out last year.  I really dont know what the best course of action is.  Any help would be great.

It all depends on your goals. I understand you'd like to pay them off to generate more net profit but why not use the funds from the San Jose property and acquire larger property or two?  Use the power of leverage. 

All you are accomplishing is transferring dead equity from one property to another. Dead equity does not increase cash flow. This is investing 101.

IF you have dead equity in a property it is killing your true cash flow due to it's opportunity value. You are actually using your own cash to buy artificial cash flow rather than investing your money to actually earn it's keep.

When you pay down a mortgage you are only earning the prevailing interest rate. No genuine investor would ever be satisfied at investing at that rate.

Take your cash, invest it in a income fund and double your returns.

Dead equity does not increase cash flow, it is not invested it is parked, dead and buried, useless for all intent and purpose. If you do not intend to make your money earn it's keep put it under your mattress so at least you can get at it if you need it.  

Dead equity is a indication of a hoarder not a smart investor.

Ian,

San Jose real estate is selling really quickly and for very high prices right now. If you sell now and and you own the home with a spouse you can use the 500K profit any way you want.

If you own it as a single many than you will be taxed on 250K worth of profit unless you do a 1031 exchange and buy other investments of equal or great value.

So the answer to the question of paying off the mortgages on your other properties or investing in another property, or holding onto the San Jose home depends on your needs and goals.

If you want appreciation then holding on to the San Jose home is fine, but the longer you hold it, the higher your tax bite when you sell, unless you do a 1031 exchange. Also when you do sell it and do an exchange, if you have a loan you will need to buy something of equal or greater value and include the amount of the loan to avoid paying capital gains taxes.  So if you owe 300K on the mortgage and sell for 850K you will have to buy another property for about 800K in order to avoid paying capital gains tax. You can subtract your cost of sale. You will need another mortgage of 300K and the 500K profit. If loan rates are much higher than your current loan you will reduce your cash flow.

If you want cash flow then selling it and paying off your other mortgages is the way to go.

If you are going to have to pay the 250K capital gain because you are the sole owner and want better cash flow than you can do the exchange, not pay capital gains, and purchase someplace with the loan + profit, but with better cash flow. The more expensive the neighborhood, in general the lower the cash flow. 

Again, you should check with a tax person to verify you do not have something specific to your situation that goes against what I am saying.

I’m not a tax person or qualified to give tax advice. But as a lay-person I will say I think you might qualify for the exclusion for owner occupants with respect to capital gains tax though. If you’ve lived in the property as your primary residence for 2 of the last 5 years, then if you’re unmarried you’re exempt from capital gains tax for up to 250k of the profit, and $500k if you’re married. (So if you’re married and you net less than $500k, no capital gains tax would be due. Also I’m pretty sure that’s calculated on net profit, so broker fees, etc. reduce the taxable gain).

If you owe capital gains tax, I’ve heard it’s somewhere in the 30%-38% range in the higher-ish brackets for CA residents but again. Not a tax person so that should definitely be checked.

With your assets and income, I hope you have a good CPA. If so, your CPA should be able to really guide you through a tax analysis!

Regarding paying off your debts... that really is up to you. You could use the money to buy more properties to create more cash flow (and the mortgages on your rentals would just continue to be slowly paid off). But if you want to wipe your hands of the time/effort of acquiring properties, that is your call. You could also do non real estate investments that may offer a higher ROR.

You’ve been really great in putting yourself in the position to have so many great options. Congrats to you!! I hope you’re super proud of your successes :)

@Ian Russell , If you lived in it until last year then you can sell that property and take the first $250K ($500K if married) of profit tax free.  If your single then you'd pay capital gains tax on the $250K overage.  However, thats still a big number in CA.  

Depending on how the numbers work out you could sell and take the $250 tax free and use that to pay down mortgages.  I'm the contrarian around here.  In a mature market $400 cash flow is absolutely nothing to weather any kind of storm.  Paid off rentals can almost never hurt you.

But secondly do a 1031 on the rest of the sale and use that to buy some other properties with leverage.  So you satisfy both urges - security and aggressive expansion.  

That's one of the really neat opportunities to investors who have converted their primary residences to rental - the ability to combine 1031 and sec 121.

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