Sell, refi or HELOC to tap equity? Advice for next step?

Question

I'm stuck in a little analysis paralysis here and would love some feedback.  I have a 4 unit in Chicago that is barely Cash Flow positive because I keep one of the units for myself but barely use it since I spend 99% of my time in the burbs.  I'd like to leverage the equity but I'm conflicted on whether I should: sell, take a HELOC or refinance to free up some cash for another Multi Family, maybe commercial bldg.  Or keep the 1st property and use as collateral for a 2nd bigger property if I can find a bank who will work with me.

Making up the numbers for simplicity sake but paid $350k, put down 20%/$70K and it is worth about $450 today.  I owe $230k on a 30yr fixed at 3.5% with about 23 years left to go.

My concerns are: losing a great rate and paying taxes/commission on a large chunk of the equity.  Upside: more units, potential good cashflow, etc.

My overall RE goals are wealth generation (retire early) with cash flow second (but always appreciated).  I have

Any thoughts would be greatly appreciated!

Dave Foster · Answer

@Matt Said, There may be a combo approach here that is to your best benefit.  First of all to answer your last question, proceeds from a refinance are not taxable.  They are not profit.  They are a loan against equity.  So feel free to explore a cash out or heloc if you can get one.

As important as the terms you can get though is going to be the performance of the property after a refinance.  Proforma it out with all 4 units rented under a new loan so you can see clearly one option.

The other option though is to sell.  And here you may have some neat opportunities.  As @Brie Schmidt and @John Warren mentioned you can take 1/4th of the gain from that property tax free.  That's no small thing to get equity out tax free without having to borrow.  But here's where it gets good.  If you want to get another property you can do a 1031 exchange and defer the tax on the other 3/4 - taking advantage of both statutes in the code.

A refi or heloc will not free up as much cash as a sale that is part tax free and part tax deferred.  So in one swoop you will generate tax free income, free up cash to purchase another property, and defer all tax on the rest.

• When the stars align like that you have to take a close look at that option.

Brie Schmidt · Answer

@Matt Said - is this your primary residence?

If so you could do a HELOC, Cash out refi, or sell and be exempt from capital gains (as long as it was your primary 2 of the last 5 years)

If not, a HELOC will be difficult, most are for primary residences only.  A cash out refi will be limited at a 70% LTV too.  Banks typically do not use current assets as collateral.

John has some good suggestions, rent it out or airbnb it - but keep that capital gains exclusion in mind

Dave Foster · Answer

@Brie Schmidt, if it was one house with common walls and shared living space he could.  But this is a 4 unit according to my understanding.  The three units he does not live in would not be eligible for the primary residence exemption - only the one he occupies.  That's why this is such a good opportunity for him.  He can take the primary residence exemption on the one he lives in.  The rest he can still 1031.

Dave Foster · Answer

@Matt Said, There will be some accountant calculation needed but you should be able to pull out your original primary residence capital allocation and profit from the primary residence side tax free.

The allocation for the investment side is subject to 1031 regs which are a little different.  The IRS is willing to leave their profit (tax) in as long as you are willing to leave your profit in.  But they figure your profit a little differently

In order to completely defer all tax in a 1031 you must purchase at least as much as your net sale and you must use all of the net proceeds in the next purchase or purchases.  The IRS choose to interpret that any amount you purchase less than you sell or any cash you take out is you taking profit so it would be taxable.

I know - it sucks right.  It's the same dollar.  You call it return of capital.  They call it profit.  They have nuclear weapons.  they win! :(

it's still a great scenario overall though.  Just not sweet as we'd like.

John Warren · Answer

@Matt Said if this is your personal residence, you might not have to pay taxes on the full amount after selling if you have lived there for 2 years. I personally would speak with someone who knows your market to make sure you are maximizing rents, etc. A lot of land lords in Chicago are giving up way too much rental upside by not raising rents to market.

I personally would run numbers to see how it would perform if you moved out to the burbs. It sounds like it would cash flow pretty well if you rented the 4th unit out. What if you looked to air BnB the unit you currently live in? A lot of land lords are making a killing off this strategy.

If you decide to do a HELOC or a refi, and cash is tight, you could see negative cash flow for a while. It is up to you to decide if a property is worth holding for appreciation with negative cash flow.

Have you checked with @Brie Schmidt? She does a lot of work in the Chicago market itself, and probably would have some good thoughts.

Matt Said · Answer

Thanks all!  I really appreciate the input, if nothing else I thinking about this differently and next step is to speak to my accountant.

Thanks!

Corby Goade · Answer

If you are happy with the cashflow once you rent out the fourth unit, I vote HELOC and leverage for a few reasons:

-You don't pay taxes on the equity you use from a HELOC

-Closing costs are free

-You get to keep the property and continue to appreciate.

-You don't pay any interest on the HELOC until you actually use it.

This is how I've built my portfolio and it's worked well for us. Good luck!

Jeff Burdick · Answer

Those are not proceeds.  They're a loan.  So not income.  Not taxable.

Jeff Burdick · Answer

Is it your primary residence?  I'd be hesitant to give up that interest rate.  A HELOC is what I would do in your situation.  Take advantage of the equity, without giving up that incredible interest rate.

Brie Schmidt · Answer

@Matt Said - if you were owner occupied 2 of the last 5 years you would get a capital gains exclusion and not need to 1031

Sell, refi or HELOC to tap equity? Advice for next step?

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