Seattle property - not sure how to evaluate primary turned rental

8 Replies

Hi! Relatively new here, and accidental investment property owner. We bought our first home (primary residence) in 2014 in Seattle (Ballard area for those familiar with the city) We paid $669k for a 4BR/2BA, 2500 Sq Ft home built in 1940. It's walking distance to everything and in a very nice, family friendly area. Has been meticulously maintained; we were only the 3rd owners. We put 10% down ($70k) and have $520k left on the mortgage. Zillow / Redfin + what I've seen in the area it would now sell for $1.05-$1.1M. 

Last summer we moved to Nashville to be closer to family and we kept the Seattle house and are renting it out. It rents for $4450 and when you back out lawn care, property management, etc. we cash flow $200/mo which we just add to our mortgage payment. The strategy was to hang on to it for appreciation. 

As suggested by many, I've been doing a lot of deal analyses just to get the practice, as we want to purchase a rental property here in Nashville with some other funds we have. My question is - how do you evaluate an investment when you switch from primary to rental? For project costs, would I just include the things we needed to do to prep for rental (some electrical work - $7k) or do I need to include my down payment as well? What about other work we did to the home while we lived there (new windows, siding, etc.)? I'm trying to get an apples to apples comparison to evaluate the options of 1. hanging on to it for X more years 2. selling it and reinvesting (1031, perhaps - we are in the highest tax bracket) here in Nashville. How do you decide when to let go of such a huge, appreciating asset and re-invest it in several smaller properties?

Hi @Crystal Hadaway , that is a tough problem you have.  When trying to decide if you should sell or not, you need to look at both options and compare apples to apples as you said.  I think you need to look at your Seattle property from this point on and not worry about the money you have already spent on it. Determine what you think the appreciation will be over the next few years and compare that with the appreciation and cash flow of your next investment.  Try to keep it as simple as possible when looking from the 10,000 foot level.

Also remember that if you have lived in your Seattle property for 2 of the last 5 years, you don't pay capital gains tax.  

@Crystal Hadaway

One big thing you need to consider-probably the biggest thing....tax

If it is a true primary, you can look into avoiding cap gains entirely. 

The other thing to consider is since you paid so much less than it's currently worth, your depreciable basis is going to be low comparative to the value of the property. When you go and sell it later down the road (not as a primary), you are going to get absolutely creamed on taxes. yes, you can still 1031 and defer taxes, but it's just a deferral. Selling as a primary with no cap gains is not a deferral. 

Sounds like you might need to talk to a tax pro before deciding for sure. 

@Crystal Hadaway , $200 is not a lot of money for this expensive property. At this point, it is pretty much getting you appreciation.

To compare apple to apple, you will need to include all the money you spent on it. If your long-term goal is to keep expanding in Nashville, you may need to think about 1031 exchange this Seattle one.

@Crystal Hadaway , As of right now all of your capital gain would be tax free because you meet the requirements of sec 121 and the gain is still going to be a little less than $500K.  You have the option of holding this house for a couple more years and still meeting the 2 out of 5 residency requirement.  So you do have a little time.  

The other thing you want to keep an eye one though is the depreciation recapture. Each year you use that as a rental is going to cost you around $5K in depreciation recapture.  This can be avoided with a 1031 exchange.  And right now you can actually take advantage of both - take the $500K deduction and do a 1031 exchange which would defer the depreciation recapture.

With a blended approach like this you would need to buy less replacement property at once under the stringent 1031 timelines.  And yet you'd also have $500K of cash in your pocket tax free waiting for the right time to buy - whenever you decide that is.

You have a little time to decide this.  But tax free is always what I prefer.

In a nutshell, you should sell Seattle and reinvest in Nashville.

Here’s how you should analyze.  Ignore the past but consider the opportunity cost.  Sounds like you have roughly 500k in equity in that property in Seattle generating next to nothing in cash flow.  You can sell (no cap gains on property tax on your primary residence for the first $500k if you are married and $250k if single) and put 20% down on 10 properties at an average purchase price of $250k that can cash flow $400 - $500 each in Nashville.  You can also hope for appreciation in Nashville just as much if not better than in Seattle.

I know I make it should easy and it is not. But it is a good plan. You might end up with a few duplexes or something larger. Focus on maximizing Cash-on-Cash ROI. You are lucky to live in Nashville where you can find good deals. Shoot me a note if you have questions

Ilan

As others have pointed out if you can sell your Seattle property and net the gains without taxes through the primary residence timeline it seems like a very wise move.  Would you reinvest 500k today into another house in that neighborhood for $200/month?  I would guess not.  That is quite a bit of capital to have available to put into a market you are closer to even move asset classes if there is something that fit's your families strategies better as you pointed out you became an accidental long distance investor.