A very conservative tax advisor who also handles appeals with the IRS told me he has never heard of the IRS ever challenging the $250,000 (for a single) tax free home owners exemption. Obviously the safe thing would be to live in it the 2 years prior to sale to get the tax free gain.
If I were in your shoes and did not want the hassle and headache from a 76 year old rental house I would sell, especially since others in California concur. I would then use the cash to buy performing first notes on well collateralized property. I would never buy the note at more than 80% of current house value. I would buy in areas I know that are investor friendly, which is easy for me since I'm in Houston and Texas and Florida are investor friendly.
You can EASILY buy well seasoned performing notes with a 10% yield. Undoubtedly there is a note buying section in Bigger Pockets and note brokers always advertise their wares. I believe there is a big online note broker in the L.A. area. You don't have to be an expert. You can hire an attorney in the state where the note was developed and the property is in to see if the note was written with good legal practices. You can hire a local real estate broker to run full photo comparables to send to you to verify value or you could hire an appraiser. This gives you the two most important criteria: good lawful first lien security via the note and knowing the accurate value of the house. Part of the promissory note package should be that the note has title insurance already, which I believe always transfers to the new note owner if the note is sold. You could also hire a reputable note broker to grade the note. My only concern being conflict of interest if it is the same broker grading the note that is brokering the note.
Having a lower loan to value provides security if the loan goes bad so a lower Loan to Value, such as under 70% gives an improved margin of safety. If the note were to go bad you simply hire an attorney to foreclose and hire a contractor to fix up, then sell the house with owner financing. You can do that anywhere in the world. You won't make as much as if you did it yourself, but it can all be handled to put you money back at work, even in the worse circumstances.
Typically you are buying the note at a discount and with relatively low Loan to Value notes, you should make even more money when the note goes bad and you foreclose.
By investing the $400,000 in performing notes you should easily be able to net $40,000 to $48,000 a year in cash flow. Remember a 10% note also spits out (a little) principle (at first) so the payment is more than a simple interest calculation. You need some reserves in case you have to foreclose and fix up before selling with owner financing or without. It doesn't matter if you sell with or without owner financing as you profit either way, but if you want cash flow sell with owner financing. You can get a higher sales price, a down payment and a higher interest rate.
The $40,000 cash you have you retain for reserves and do not use it. That is your reserves to foreclose and fix up any note that goes bad. You have at least $3,750 to $4,000 per month cash flow when the notes are performing so that is way more than you need to live luxuriously in Chiang Mai or most anywhere. Save at least the principle and reinvest so the money stream never stops. If you are lucky, some notes pay off early and if you bought at a discount you make an even bigger profit and have more cash to reinvest to buy larger face value notes. Others you foreclose and turn into bigger notes. When things go "bad", you work through the process and end up in a better position than where you started. When things go "good" they are good. All results are good, long term, as long as you have value, proper legal security/collateral, buy at a safe LTV and have sufficient reserves to "cure" any potential bad spots.
If you want to cash out your notes, you may have to sell at a loss if you didn't buy them deep/cheap enough but you can always sell them. Typically if they are performing, you get closer and closer to true note value the more the note is seasoned. The note discount is otherwise most affected by the difference between the yield required by the investor and the inherent interest of the note. For example an investor wanting 10% always buys a note with a stated interest rate of 8% at a discount. If you want more liquidity don't use the entire $400K on buying notes, buy what makes you comfortable between income and liquidity.
I have sold a couple houses owner finance and tried to talk my cousin into buying part of the note giving him a safe secure 10% return. With me still holding some of the note and being local to the collateral property, if things go bad I would have foreclosed, fixed up and sold - allowing him to reap some of the new gains, in exchange for allowing me time to cure the situation and re-profit. You know how it is trying to work with relatives, he liked the idea until being asked, then had no interest even though he was concerned about uncertain investment gains or losses with investments he had. I've since found a couple brokers that obtain insurance company money where I can get wrappable loans, so that's a different approach that is an answer to my same issue. Both cases allow me to create more notes than my pocketbook alone could do. Something like that (having a partial note/built in partner) could also be good for you as it provides not only the security of the loan, but also a more likely path to future profit if the loan goes bad by already having a "built in" partner whose interest in making the deal perform are exactly aligned with your own. Essentially that built in partner is found by buying a partial note, though you would likely have to talk with the other partial note holder about methods of securing his/her interest if the note goes bad. In my case I was going to create a synthetic first and second note, from the single note obligation - giving the first holder (you) priority but further delineating the process of how the subordinate partner would have the right to foreclose, fix and resell and both partners share in the new profit, or simply abandon their ownership which leaves the first holder with more equity. I suppose the downside terms would not have to be agreed upon prior to the note going bad. If you had a partial note (with primary/first interest) you could make an offer to the subordinate note holder to protect his/her interest by foreclosing, fixing and reselling. That would give you the local hands-on partner, providing the other partial note holder lives in the same area as the house. I think that is a likely scenario with a partial note as it seems an investor would occasionally want to sell partial notes for cash. Since it is further likely that very same investor created the note and therefore is likely to be local, in most situations of buying a partial note the local "partner" is likely the one selling the partial note. The same could be said of a 1st and 2nd note where you are buying the 1st from an investor who retains the 2nd. The 2nd note holder could be your built-in partner if things go bad. That's how you get large sustainable income from the equity you have with no property management.
