Selling vs. Refinancing
You own a rental property for years, and never see the “big payoff.” Is it time to cash in on your investment, now that you’ve paid down the mortgage, and values are up? Maybe not.
The Problem With Selling
Selling means you’ll have to pay a large capital gains tax. This can be avoided if you reinvest through a 1031 exchange, but then the point is that you want your money, right? Also, a good rental gets more income as rents go up. Do you want to lose this inflation-indexed retirement plan? What’s the alternative?
Refinancing Rental Property
Have you considered that if you refinance, you can get much of your gain out of the property, without paying a penny in taxes? Borrowing money is not a taxable event. You can take it and spend it however you want, and still keep your rentals.
Let’s look at an example. Suppose you have owned a small apartment building for years. You bought it for $240,000, with a down payment of $40,000, and mortgage payments of $1650 monthly on the balance. Now it is worth $400,000, you only owe $120,000, and your cash flow is around $800/month. How do you get at that equity?
A bank will probably loan you 70% of the value, or $280,000. After paying off the first mortgage, you are left with $160,000. With today’s lower interest rates, your payment on the new mortgage will be about the same. At most you might lose $50/month in cash flow.
An even better scenario: Use $40,000 for high-return upgrades to the property, such as carports, common area improvements or laundry rooms, and then raise the rents. You could have $120,000 left over to spend any way you want, AND have higher cash flow. Does that sound better than selling your retirement plan? Don’t sell. Refinance that rental property!