Author Topic: Likely to sell my paid off rental eventually: check my logic  (Read 4231 times)

Bearded Man

  • Handlebar Stache
  • *****
  • Posts: 1137
Likely to sell my paid off rental eventually: check my logic
« on: October 16, 2015, 04:20:20 PM »
I bought the house in Tacoma, WA for 64K five years ago. It is worth about 150K now. After expenses, I make about $8,400 a year in cash flow. Again, this accounts for taxes, insurance, maintenance, etc.


Even though it is a rental now, I lived there longer than any of my current homes though the one thing I didn't care for there was the traffic noise from a somewhat busy street. Not a major road, but enough people use the side street that the swoosh of cars get's annoying, mostly because it is sporadic. 5 cars at a time during rush hour, minutes apart, or one car every few minutes during the day. After about 8 PM it is pretty dead.

Thing is, right now I'm holding it because I like it as a fall back position: a paid off place to live with a reasonable commute to high paying jobs, transit, entertainment, etc. But as the value rises I think I might be better off either

A) 10-31 exchanging into a similar house in the same area that is not on a busy street. Basically, I look at it like I'm trading one house for another, so as far as I'm concerned, I still paid 64K for it. This way I can keep renting it out, and it's a better place to live should I want to keep using it as a fall back position.

B) Sell it and use the money to finance several properties. This is something I had not really considered until I saw a few youtube videos where the investors with 50+ houses tell you how they turned a little into a lot.

I think either one is a winning strategy. Option A gives me more safety and improves the living situation if I ever do decide to move back in. Heck, if it was not on a busy street, I'd probably move back in NOW.

Option B allows me to build more wealth, especially in the long run. For a fall back position, I can always buy one of those 50K houses in Idaho :-)



Drifterrider

  • Handlebar Stache
  • *****
  • Posts: 1118
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #1 on: October 21, 2015, 05:22:57 AM »
Have you considered moving in for two years then selling so you can have the capital gains as non-taxable?

MetalCap

  • Stubble
  • **
  • Posts: 132
  • Location: Washington DC
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #2 on: October 21, 2015, 10:30:18 AM »
Take a look at the cash-out refinance. For an 80% LTV you'd have 120k to invest in new properties AND keep the rental which seems to cash flow nicely. Best of both worlds.

clarkfan1979

  • Magnum Stache
  • ******
  • Posts: 3352
  • Age: 44
  • Location: Pueblo West, CO
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #3 on: October 21, 2015, 10:41:47 AM »
Have you considered moving in for two years then selling so you can have the capital gains as non-taxable?

I don't think this exists in the tax code anymore. A few people have mentioned it in a few other threads.

Ricky

  • Pencil Stache
  • ****
  • Posts: 842
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #4 on: October 21, 2015, 12:13:20 PM »
Well you can combine option A with option B and use a 1031 for multiple properties.

Drifterrider

  • Handlebar Stache
  • *****
  • Posts: 1118
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #5 on: October 22, 2015, 09:59:16 AM »
Have you considered moving in for two years then selling so you can have the capital gains as non-taxable?

I don't think this exists in the tax code anymore. A few people have mentioned it in a few other threads.

IRS publication 523.  Don't take legal, medical or relationship advice from the internet. 

Ricky

  • Pencil Stache
  • ****
  • Posts: 842
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #6 on: October 22, 2015, 09:45:17 PM »
Have you considered moving in for two years then selling so you can have the capital gains as non-taxable?

I don't think this exists in the tax code anymore. A few people have mentioned it in a few other threads.

IRS publication 523.  Don't take legal, medical or relationship advice from the internet.

Yes you can still do it, it's just a pro-rated calculation now and you won't get the full $250k deduction, though I doubt he has owned it long enough to see $250k in appreciation so it shouldn't be an issue.

Bearded Man

  • Handlebar Stache
  • *****
  • Posts: 1137
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #7 on: October 23, 2015, 10:39:08 PM »
Actually, I lived in it for the first 2 out of the 5 years already. And furthermore, some of the comments people keep talking about in other threads about non qualifying use gains not being exempt are inaccurate.

That rule was changed in 2009, which was designed to keep investors from getting a pass on capital gains buying properties as outright rentals. If you live in the house FIRST and THEN rent it out, you are golden. Non qualifying use can only occur BEFORE the house was used as a principle residence. If you lived in the house first, then rented it out, then moved back in, so long as you are within the 2/5 year rule, even if you've owned the house for 10 years, you don't owe capital gains. Now if you bought it as a rental and only moved into it AFTER it was rented out, then yes, the capital gains are pro-rated. Interestingly enough, if you move back out of the house again in this scenario, the capital gains from rental periods after you lived in it become exempt from capital gains tax again. Again, because non qualifying use can only occur BEFORE the house was used as a principle residence.

http://www.nolo.com/legal-encyclopedia/taxes-when-you-convert-your-rental-property-your-personal-residence.html

Cathy

  • Handlebar Stache
  • *****
  • Posts: 1044
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #8 on: October 24, 2015, 12:21:06 AM »
Non qualifying use can only occur BEFORE the house was used as a principle residence.

This is not accurate. I imagine you are thinking of the exception set out in 26 USC § 121(4)(C)(ii)(I), but you have not stated it correctly; it is more limited than the quoted text suggests.

Rather than explain the law, I will yet again link to the same Kitces article where all this information is accurately explained. As I have previously explained, you cannot rely on nolo.com for legal or tax advice. In this case, the nolo.com page is unquestionably wrong when it says that "[a] nonqualified use can occur only before the home was used as the taxpayer’s principal residence". That is simply not an accurate statement of the law in general, even if it happened to be accurate in the specific example given on the nolo.com page.

I express no view on Bearded Man's specific situation. His capital gains may or may not excluded from income depending on all the facts. No view is expressed on that. I also express no view on the contents of any of the posts in this thread other than the specific quote to which I responded. The fact that I have refrained from responding to something in the thread does mean that it is accurate.

I want to be very clear about this because I can pretty much anticipate that somebody will be tempted to respond and argue against things I didn't say, so let me be extremely explicit: I am not commenting on Bearded Man's specific situation. I am not commenting on anything other than the text quoted above, which happens to be incorrect in general, even if it's true for Bearded Man's specific case (on which I express no view).
« Last Edit: October 24, 2015, 12:41:54 AM by Cathy »

Bearded Man

  • Handlebar Stache
  • *****
  • Posts: 1137
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #9 on: October 24, 2015, 12:46:00 AM »
I've read Kitces article. First time I read it was years ago. That's where I first learned of the non qualifying use exclusion. The article on nolo backs up what I said. It was written by a tax attorney. Kitces article proves my point. I read it years ago and have it bookmarked. It also matches what the tax attorney on Nolo said. If you read to example 3 it clearly states the exclusion as I noted it above.
« Last Edit: October 24, 2015, 12:59:18 AM by Bearded Man »

Bearded Man

  • Handlebar Stache
  • *****
  • Posts: 1137
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #10 on: October 24, 2015, 12:52:50 AM »
Kitces article backs up what I said and what the tax attorney said.

Did you read the whole thing?

Quote
Fortunately, while the rules do limit the exclusion of capital gains attributable to periods of nonqualifying use (after 2009) in the case of a rental property converted to a primary residence, the rules are more flexible in the other direction, where a primary residence is converted into a rental property. IRC section 121(b)(4)(C)(ii)(I) allows taxpayers to ignore any nonqualifying use that occurs after the last date the property was used as a primary residence, though the 2-of-5 ownership-and-use tests must still be satisfied.

Example 3. Donna has lived in her property as a primary residence since 2008. In 2012, she received a new job opportunity across the country, but decided she didn’t want to sell the property yet as home values were still recovering in her area, so she rented the property instead. Now, in 2014, as home prices have continued to appreciate, she wishes to sell the property. Even though there have been 2 years of otherwise-nonqualifying-use as a rental, Donna does not have to count nonqualifying use that occurred after she lived in the property as a primary residence. As a result, all gains will be treated as qualifying, and eligible for the capital gains exclusion (except to the extent of any depreciation recapture). Even though Donna does not still live in the house as a primary residence, she has still used it as a primary residence in at least 2 of the past 5 years (as she lived there in 2010 and 2011 before renting in 2012), so the Section 121 exclusion is available. However, it’s notable that if Donna waits until 2016 to sell, at that point there will be 4 years of rental use and only 1 year of use as a primary residence, so Donna will lose access to the Section 121 exclusion simply because she no longer meets the 2-of-5 ownership-and-use test.
« Last Edit: October 24, 2015, 01:08:45 AM by Bearded Man »

andyp2010

  • 5 O'Clock Shadow
  • *
  • Posts: 93
  • Location: NZ
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #11 on: October 24, 2015, 12:54:53 AM »
Wait, why would you sell?

Keep the property, it clearly has decent capital gains and you can lever off it financially. Why does it matter if it's on a busy street if it's making you money from a cashflow and CG point of view? It's not a home once you move out, just a magic money making box.


Bearded Man

  • Handlebar Stache
  • *****
  • Posts: 1137
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #12 on: October 24, 2015, 01:02:07 AM »
I mentioned this above but was not entirely clear.

I would sell because I can get higher returns for less work and risk. The busy road is an issue if I want to move back into it as a fallback position since it is paid off. I could use the money on a better house location. I like having a paid off house as a fall back, but wouldn't want to move there for too long. Either I sell and buy vtsax, or I exchange for a better house. Excuse typos, phone typing...
« Last Edit: October 24, 2015, 01:05:20 AM by Bearded Man »

Cathy

  • Handlebar Stache
  • *****
  • Posts: 1044
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #13 on: October 24, 2015, 01:17:12 AM »
Kitces article backs up what I said.... Did you read the whole thing?

The Kitces article, including the part you quote, does not say the same thing as the text I quoted above and stated was incorrect.

There is a very significant difference between "taxpayers [can] ignore any nonqualifying use that occurs after the last date the property was used as a primary residence" (quote from the Kites article) and "Non qualifying use can only occur BEFORE the house was used as a principle residence" (the incorrect statement from your post and the nolo.com article). Understanding the difference between those statements is the kind of reading comprehension skill that is necessary to excess at legal research.

Lately I have been consistently regretting posting on this forum because people endlessly argue against things I haven't said and do not correctly read the things I do say. I do not make these posts as some kind of "gotcha" exercise to point out mistakes and make people feel bad. I do it because I wouldn't want somebody to rely on incorrect information. I'm sorry if that upsets you.


...The article on nolo backs up what I said. It was written by a tax attorney....

The error on nolo.com that I identified in another post was in an article purportedly written by a lawyer who supposedly specialises in employment law, and yet it contained a basic error about employment law in the United States. You cannot draw any conclusion from the fact that the person who wrote the article claims to be an authority on the topic.

The reason I consistently recommend the Kitces article is that it is accurate, not that it was written by Kitces.
« Last Edit: October 24, 2015, 01:29:39 AM by Cathy »

andyp2010

  • 5 O'Clock Shadow
  • *
  • Posts: 93
  • Location: NZ
Re: Likely to sell my paid off rental eventually: check my logic
« Reply #14 on: October 24, 2015, 04:37:39 AM »
I mentioned this above but was not entirely clear.

I would sell because I can get higher returns for less work and risk. The busy road is an issue if I want to move back into it as a fallback position since it is paid off. I could use the money on a better house location. I like having a paid off house as a fall back, but wouldn't want to move there for too long. Either I sell and buy vtsax, or I exchange for a better house. Excuse typos, phone typing...

I'm still not sure where selling it would give you an advantage.

At a conservative 80% LVR, your available capital looks something like this (assuming you have the serviceability).

Value - $150k
Cash needed to leave in - $30k

Available for Investment - $120k deposit or roughly $600k worth of property, available to you right now, whilst keeping a decent asset. At a higher leverage even more but you come across as a conservative investor so probably best at 80% or less depending on what you're comfortable with.

Is the $8400 cashflow the profit or just the gross income? If it's the profit then that's pretty good. Especially if you've got someone else looking after it.

Buying and selling (trading) is a difficult game of chance filled with spruikers and fools sprinkled in with a smattering of people that actually know what they're doing, buy and hold is much more predictable generally.

I think you're in a really good position without even realising, a great broker will get you to the next level :)