Sell or Rent primary home? CA tax question.

[Lady Stash]

I have decided to move from my primary home this year.  All else being equal, I'd prefer to sell the house and buy another one in a new location. 

As I look into the numbers, it's looking like I'll take such a huge tax hit that it may be worth renting it out instead.  Would appreciate your thoughts.

It's a single family home in San Diego.  I paid 200K for it in 2000.  It's now worth approx 800K.  It's gone up about 100K over the past year with the recent run up in real estate.  (Redfin estimates 760K. Zillow estimates 880K).   

If I sell the home for 800K, I will realize approx 550K in gains (800K sale price - 200K original price - realtor fees = ~550K).  250K of that gain will be tax free.  That leaves me paying taxes on 300K.   I'm in the top tax bracket in CA, so I believe I'd owe approx 45% tax on that 300K gain for a tax bill of ~135K.
 
I'd also lose my grandfathered tax basis.  California property taxes are grandfathered in via Prop 13 so despite owning an 800K home I pay property tax on its 2000 value of 200K plus a modest 2% increase per year.  So I pay approx $3400 in yearly property tax where a new buyer would pay approx $9K.

It feels like it might be worth the hassle to rent it out.  Perhaps I can do a 1031 property exchange once I've settled somewhere to move the rental closer to me.  Zillow estimates it will rent for 3K/month.  I might be able to get 3.5K/month.

Am I missing any options here?  What would you do?

[affordablehousing]

uh, can't you buy a spouse for a month, do the sale then get annulled? You double your shelter. Otherwise just 1031 it into something more profitable.

[Another Reader]

I would rent it out and then 1031 into rentals closer to your new home. California will follow you and require you to pay the capital gain if and when you sell, so I would just collect the rent and let the next generation get the stepped up basis, if it is still available.

[jac941]

So many perverse incentives for keeping property in California. There is this ongoing joke among the people we know that none of us can ever move because the financials will never make sense. I think it contributes to the insane market.

I don’t have a better suggestion than the previous two posters - 1031 it. But the thought of becoming a long term landlord is horrifying enough to me that I might be inclined to just take the hit. Will you be FI after the sale?

[bryan995]

Why on earth would you leave San Diego!? 🌮 🏖 ☀️. 🤣

I’d def keep it and rent it out. SD is on fire and it should only continue. Then later you can 1031 or if you end up with a spouse, you can sell with morels a  tax shelter.

[Sandi_k]

You can't 1031 your primary home.

[jac941]

You can't 1031 your primary home.

Correct. But after renting it out for a couple years it won’t be the primary home anymore and then the OP could 1031 it. That is why everyone is suggesting to rent it. I doubt the rent vs sell for that particular property works  on paper. The only way it is likely to make sense to rent is if the plan is to do a 1031 later.

[Spicolli]

Does the Prop 13 rule about only increasing 2% per year apply if it's turned into a rental? Our rental house's property taxes went from $4K to $7K over the last 7 years.

[jac941]

Does the Prop 13 rule about only increasing 2% per year apply if it's turned into a rental? Our rental house's property taxes went from $4K to $7K over the last 7 years.

Prop 13 prohibits reassessment except when there is a change in ownership or completion of new construction. It applies whether the owner is an individual or corporation. Renting the property has no impact on the property taxes.

[iluvzbeach]

Don’t certain expenses over the 20+ years you’ve owned it get added in to your cost basis? Has there been any significant event (such as death of a spouse or previous co-owner) that would reset your cost basis?

If you don’t think you’ll ever return to SD, I’d try to figure out the best way to reduce the tax hit while liquidating.

[Sandi_k]

You can't 1031 your primary home.

Correct. But after renting it out for a couple years it won’t be the primary home anymore and then the OP could 1031 it. That is why everyone is suggesting to rent it. I doubt the rent vs sell for that particular property works  on paper. The only way it is likely to make sense to rent is if the plan is to do a 1031 later.

But then if it's a rental home, you lose the capital gains exclusion entirely, AND you have to pay recapture of depreciation if/when you sell.

If you can guarantee that you will NEVER sell, maybe it would be worth it?

[Dicey]

Does the Prop 13 rule about only increasing 2% per year apply if it's turned into a rental? Our rental house's property taxes went from $4K to $7K over the last 7 years.

Unless you did permitted work, that's just plain wrong. More details please.

[Spicolli]

Does the Prop 13 rule about only increasing 2% per year apply if it's turned into a rental? Our rental house's property taxes went from $4K to $7K over the last 7 years.

Unless you did permitted work, that's just plain wrong. More details please.

We bought in 2005 for $540K as our residence, turned it into a rental in 2010, since then our property taxes have been 4.4K, 4.4K, 4.2K, 3.9K, 4.5K, 5.1K, 5.3K, 5.3K, 6K, 6.4K, & 7.1K. No permitted work was done. Would they take the bought price and be able to add 2% per year despite there being some years that the assessed price was lower than the bought price? Because 5.4K growing at 2% for 15 years is 7.1K

[Kayad]

If I sell the home for 800K, I will realize approx 550K in gains (800K sale price - 200K original price - realtor fees = ~550K).  250K of that gain will be tax free.  That leaves me paying taxes on 300K.   I'm in the top tax bracket in CA, so I believe I'd owe approx 45% tax on that 300K gain for a tax bill of ~135K.
 

I don't understand how you get to 45% tax.  At most isn't it 20% federal capital gains, + 12.3% California state income tax, for a total of 32.3%?  Still a big tax bill (~97k). . . .

[yachi]

I second Kayad, you may be forgetting the federal tax will be at the capital gains rate instead of the income tax rate.  One thing to keep in mind, is you only have to own the house for 2 of the last 5 years to qualify for the 250K homeowner exclusion.  So if you decide the try the landlord route, you have maybe 2.5 years to change your mind, and still qualify for the homeowner exclusion.

[Omy]

Sell and take the money and run...unless being a landlord is part of your long term strategy. Frankly, it can be a real PITA.

Once you start depreciating a rental, you will now have to deal with recapture taxes AND capital gains when you eventually sell. 1031 exchanges may not be around forever and capital gains taxes are likely to be higher than 20% in the future. And the exclusion of $250k goes away. And you will need to repair/update your home after every tenant and be subject to landlord-tenant laws that are usually very tenant friendly. And deal with vacancies and more complicated taxes and record keeping.

$97k tax hit on a $550k gain isn't as bad as it seems (from a long term tax strategy.)

[trollwithamustache]

1. why do you think you can get more than the Zillow estimate in rent? (serious question. is there something more desirable about your property?) 

2. And after you pay a management company to deal with problems what do you think will be left over?

3. And, currently we in CA are still in a state of emergency, which means your future tenets don't have to pay you if they don't want to.

[bryan995]

1. why do you think you can get more than the Zillow estimate in rent? (serious question. is there something more desirable about your property?) 

2. And after you pay a management company to deal with problems what do you think will be left over?

3. And, currently we in CA are still in a state of emergency, which means your future tenets don't have to pay you if they don't want to.

CA has already solved #3!
https://www.nytimes.com/2021/06/21/us/california-rent-forgiveness.html

Unfortunately, when my in-laws visited last month, they failed to pay our $49,000/weekly rate. I've been meaning to follow up with them for payment, but now I can simply file a claim :)