Author Topic: Case study: Rent or sell  (Read 2032 times)

Rein1987

  • Stubble
  • **
  • Posts: 149
Case study: Rent or sell
« on: January 18, 2015, 05:29:20 PM »
A townhouse bought 4 years ago by mu husband, before our marriage. We recently bought a larger new house because we plan to expand our family. We will move in to the new house soon, and we are wondering which market the old one should go.

The townhouse is a 2b1b in the heart of bay area. The housing price is crazy here. Here's the info:
Market value: 500k - 600k (our neighbor with the same floor plan sold for around 550k last summer)
Purchase price: 320k
Current mortgage: 15yrs fix @ 2.75%. around 220k remaining
We pay $2300 every month including mortgage + hoa + property tax
According to zillow, the rental price will range $1900 - $2900
It is close to many major employers, so we think it would be easy to rent it out.

some information about my family:
Me 27. husband 35. Both engineers. No kids yet but plan to have soon. high tax bucket.
We can afford to keep this townhouse in vacant in the worst case. The two loan (plus property tax, hoa, insurance, etc) together will be about 40% of our take home pay. Last year, our take home saving rate is 58%. (health insurance, fsa, 401k, life insurance is deducted from paycheck so not considered in take home pay)
If we want to keep this townhouse, we may refi it into 20years or 30years or pay down the mortgage to have cash flow.
After the downpayment of our new house, we do not have much liquid at hand now, around 100k - 150k. (well, I know I bought an expensive house but bayarea house IS crazy...)

My instinct is to sell the house, but my husband though rent may be better. I thought it's hard to manage the rental. Also, if we sell, we can get about 300k, which may generate more cashflow than the rental.
My husband thought, if one day we cannot afford the new house, or want to downgrade our living, our old one would be a nice choice. Also, the old town house is less than 2 miles away from our new house, so not a big deal to manage the new one. In addition, we both have parents or siblings living in another country. If they would love to move to the US, we can offer them our old town house to live.

My question is, just from financial prospective, which one is better? Is it possible for us to rent it out for 3 years and then sell but also claim the full capital gain without tax, because we live there as our primary residence for 2years in the past 5 years? How does tax work for the rental in our case? Thank you.

waltworks

  • Magnum Stache
  • ******
  • Posts: 4720
Re: Case study: Rent or sell
« Reply #1 on: January 18, 2015, 05:37:59 PM »
Terrible 1% rule fail. Sell, unless the non-financial reasons (want to offer relatives a place to live) are more important to you.

-W

SaintM

  • Guest
Re: Case study: Rent or sell
« Reply #2 on: January 18, 2015, 08:33:04 PM »
The tax benefits of having a rental are considerable because of the depreciation deduction.  But they tend to decrease if you make too much in the IRS' eyes. You will likely have a little positive cash flow that is not taxed, but cannot offset other income because you make too much.

You are correct with the 2 in 5 years rule. However if you sell without meeting the 2 in 5 rule, you can do what is called a 1031 exchange to another income property (residential real estate, storage units, oil well, and many more(but not stocks/bonds/mutual funds)). Your gain in the house is transferred to the next property, which defers the tax. By then, your gain would likely be huge because of continued appreciation and you can depreciate the house over time.

ShoulderThingThatGoesUp

  • Magnum Stache
  • ******
  • Posts: 3054
  • Location: Emmaus, PA
Re: Case study: Rent or sell
« Reply #3 on: January 19, 2015, 05:27:31 AM »
If your husband lived in it at least 2 years out of the last 5, you pay no capital gains tax on it (maybe only the first $250k of capital gains, I am not an accountant or lawyer, just sold a house this year). That's an enormous tax-free capital gain that you could redeploy. And I wouldn't want to have the percentage of your net worth that I'm imputing from your post invested in Bay Area real estate.

jnc

  • 5 O'Clock Shadow
  • *
  • Posts: 99
Re: Case study: Rent or sell
« Reply #4 on: January 19, 2015, 07:01:26 AM »
Go on Craigslist to get some good comparables in terms of rent. 1900 to 2900 is a huge range and Zillow is not that accurate for rents. CL rules for determining rental rates.

Bay area rentals are not great in terms of cash flow but you are essentially banking on appreciation. As you saw your husband's property has almost doubled in price in 4 years, so while the growth is likely to be less substantial, I would expect it to continue to be strong in the next few years.

So it all depends on your time frame. If you are thinking short term, it sounds like selling the property and banking most/some of that money tax free would be quite appealing.

Rein1987

  • Stubble
  • **
  • Posts: 149
Re: Case study: Rent or sell
« Reply #5 on: January 19, 2015, 10:55:52 AM »
Thanks for the suggestion. So it seems sell sounds better from the short term financial perspective.

As for the actual rent price, my expectation would be around 2500, or at least 2200. Before I got married last year, I rent a studio in the same area, which costs me $1800 a month. This home has 2 bedroom, so I definitely expect more.

waltworks

  • Magnum Stache
  • ******
  • Posts: 4720
Re: Case study: Rent or sell
« Reply #6 on: January 19, 2015, 12:08:36 PM »
You are at 1/2 of the 1% rule that investors consider a bare minimum for considering a rental property, even at the top of your rental range. Of course, the house might keep appreciating and you could still make money. If it doesn't, you lose horribly, though.

-W