I am purchasing a new primary residence soon. Sell or rent my current primary?

Question

We are purchasing a new primary residence in approximately 6 months. Should I sell or rent our current primary. Current home should rent for $2,500 per month. We owe $250k with a 3% mortgage and a HELOC for $150k at 10%. Home will sell around $425k. We currently earn $250k per year and have no other write offs, so I believe this would be a great tax strategy to create LLC for rental. But, we also have $200k debt beside mortgage and HELOC. Looking for pros and cons.

Hossein Sharifi · Answer

After the 3% mortgage, taxes, insurance, maintenance, and vacancy, $2,500 rent likely won't cover much of that 10% HELOC. Unless you'd happily buy this house as a rental at today's price, selling to clear the HELOC is probably the stronger move. An LLC won't change the tax picture much. The bigger question is your capital gains exclusion: if you've lived there 2 of the last 5 years, renting it too long can cost you that.

Jaron Walling · Answer

100% agree with @JD Martin. Without the PITI, estimated capex, repairs, vacancy, or PM we can't give great advice. These questions pop up all the time. If the intent mostly like years ago was to buy, live for a few years, and then hold as a rental the numbers should support it.

You make a quarter million per year with $200k in bad debt. Selling the house tax free and wiping that out would be a huge win. It's way more powerful than fixating on the 3% rate and justifying to hold as a rental. A small amount of CF isn't worth it for someone in this position.

JD Martin · Answer

The LLC is unnecessary just to have a rental. Quick mental calculations says you will take in less in rent than you are paying out on mortgages, not to mention maintenance and upkeep. Based on your limited info and your debt load I would sell.

Dave Foster · Answer

@Harold Penovich, both options can work, but the right choice depends on all those variables brought up. Fortunately you do have quite a bit of runway available to determin your best direction.

Because this has been your primary residence, you may qualify for the Section 121 exclusion—generally up to $250,000 of gain for a single filer or $500,000 for married filing jointly—if you meet the ownership and use requirements and have lived in the property for two out of the previous five years. This could be an attractive way to sell with little or no capital-gains tax.

But even if you convert the property, you will still have exactly three years from when it became a rental to take advantage of the primary exclusion. If you find that it isn't the best rental for you.

If you convert the home and are past the window for the primary residence exclusion, you could still take advantage of a 1031 exchange. A 1031 allows you to indefinitely defer all of the tax and reinvest it into another investment property/properties in any state.

Theresa Harris · Answer

Sell (or stay in your current home), don't rent it out. Between the mortgage and HELOC, you aren't going to walk away with any money ($425K sales price minus fees and $250K mortgage and $150K HELOC) to pay off your $200K in other debt. Sit down and figure out how much the other debt is costing you (including interest) and focus on paying it down now that you are making more money. Once you've paid off the HELOC and the $200K debt, then think about investing. By that point you will be used to living off less (as a good portion of your money will have been going to paying off your debt) and you will be able to save a down payment for a rental.

Rick Albert · Answer

A couple of things:

What does the market look like in your area? Do you see trends that would suggest increasing rents?

What is the condition of the home? Would your repairs and cap ex be low?

What would you do with the proceeds from the sale of the home?

Patrick O'Sullivan · Answer

I'd talk to a lender about the new purchase first, because that may decide this for you. With commission income, lenders often average the last two years, so a lean first year could bring your qualifying income in well below what you earn now. If you keep the current house, both loans and the HELOC count against you, and usually only part of the rent gets credited. Add the other debt, and the DTI on the new loan could get tight.

I'd also run the sale math carefully. After selling costs and paying off both loans, there may not be much left over. Selling mostly clears the HELOC payment, not the other debt.

Noah Corwick · Answer

Hi @Harold Penovich. You had mentioned on one of your replies being able to pay off some of the debt quickly. It depends on what exactly "quickly" means, but if this is accurate, then paying off the HELOC and renting the property out might be lucrative based on your $2,500/month rent projection and the 3% rate.

If "quickly" means any significant time beyond your 6 month window, then selling the property will likely make the most sense since the rental income would not come close to your total PITI.

Like others have suggested, I'd also talk to a CPA about this scenario and get their take on it as well.

Jules Aton · Answer

I agree. My first thought was what does it look like when considering the capital gains exclusion? Congratulations on your new position. Attempt to avoid lifestyle inflation and your future self will thank you.

Jaron Walling · Answer

Harold, it's hard to talk with people about money. Coming to the forums and discussing your property, bad debts, and plans is a massive educational leap forward so congrats. People don't like to admit 2nd mortgages, or HELOCs. Until they talk to experienced people they usually continue to make poor choices with money.

I'd strongly consider selling. You're in a great position (on paper) but cleaning up the debt will set the foundation you need to really excel. You'll be in a better position to buy again and have the strategy(s) to back it up. If you do decide to sell wait until the spring to list. Mid terms and seasonality is really hurting pricing. Cheers.

I am purchasing a new primary residence soon. Sell or rent my current primary?

I am purchasing a new primary residence soon. Sell or rent my current primary?

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