Sell for capital gains exemption or continue holding

[Adam K.]

I’m coming up on the expiration of my eligibility for section 121 capital gains exemption on my California house. I have a little over one year before I no longer meet the 2/5 years residency requirement. 

It’s a 3/2 in La Habra CA. Nice quiet area right near the Brea border. Great 3.125 rate. Solid tenants who take care of the place and pay on time. No PM has been necessary. 

I would be looking at clearing $325K+ tax free. 

Rent is $3750 vs $2250 mortgage. I have a HELOC on the property that funded down payments for other rentals out of state. Which wipes out my cash flow.

Is selling primarily for the 121 exemption a regrettable trap? 

I don’t have another RE play lined up.

[Christopher Tile]

Quote from @Adam K.:

I’m coming up on the expiration of my eligibility for section 121 capital gains exemption on my California house. I have a little over one year before I no longer meet the 2/5 years residency requirement. 

It’s a 3/2 in La Habra CA. Nice quiet area right near the Brea border. Great 3.125 rate. Solid tenants who take care of the place and pay on time. No PM has been necessary. 

I would be looking at clearing $325K+ tax free. 

Rent is $3750 vs $2250 mortgage. I have a HELOC on the property that funded down payments for other rentals out of state. Which wipes out my cash flow.

Is selling primarily for the 121 exemption a regrettable trap? 

I don’t have another RE play lined up.

Hey @Adam K. If I were you, I wouldn't sell the property.

The Section 121 exclusion is a powerful tool, but a tool only creates value when you have a job for it. Selling a cash-flowing property in a supply-constrained market (pretty sure La Harba is based on a quick search, but you can correct me), at a 3.125% mortgage rate that no longer exists in today's world, without a clear plan for the $325K... that's trading a long-term wealth-building asset for liquidity you don't currently need. 

Let's talk about what you'd actually be giving up. That 3.125% rate is not a small thing. Rates today are sitting in the 6.5–7%+ range, and there's no realistic path back to where you are. Every month your tenants are paying down that mortgage at a borrowing cost that is essentially half of what the market charges today. Put it this way, you cannot buy your way back into that position.

Once the HELOCs are paid down, you'll have a cash flow machine. If rates come down to a somewhat comparable amount down the road, you can cash out-refi at a slightly higher rate than what you have locked in now and still cash flow. Cash out refi is also tax-free proceeds. 

That's my take as someone who likes to save clients as much on taxes as possible. If you need the money or will use it for another deal, the conversation changes.