Primary residence...should I sell?

[LAGuy]

So, I bought a place to live in here in Los Angeles in 2011. Lucky me, bottom of the market. It's in the rapidly gentrifiying area of downtown. I've seen some pretty substantial appreciation in that time. I'm starting to push up against the $250,000 capital gains exception. After that, the tax hit starts to look massive. Especially here in tax happy CA (where there is no special capital gains tax rate...you just pay the ordinary income tax rate of 9.3%). Thus, any gains over that $250,000 are looking at getting taxed at like 25%. Plus, if you hold longer and end up with even more gains (something like over $400,000 including your income for the year) you're looking at 35% marginal rate PLUS getting socked with some special Obamacare tax as well as AMT. I mean it's murder! Even if you think the property is going to continue to appreciate, does it make sense to hold it much over that $250,000 gain? Especially if your plan is like mine and you want to FIRE somewhere outside of high cost CA?

I love the place and where I live, it's super close to where I work, but it seems financially it makes zero sense to hold much beyond that $250,000 exception. How can you possibly make the numbers work with those kind of tax rates? Sell and rent seems to be the best option. Sell and buy would just up my property tax basis. What say you?

[AlexK]

You still get to keep the other 75%, which will help the FIRE plan not hurt it. I do think you are kidding yourself when you think you know the future value though.

[LAGuy]

You still get to keep the other 75%, which will help the FIRE plan not hurt it. I do think you are kidding yourself when you think you know the future value though.

I totally hear you on future value. That's kind of my concern here! I mean, even if we KNEW the price was going to continue to go up at the crazy rates we've seen the last few years, is it still enough to overcome those crazy tax rates? When the alternative is to rent and invest the proceeds from selling. Including my down payment, principal paid, and appreciation I probably have about $350,000 tied up in the property. I mean it's a good problem to have and all, but it's not a position I really expected to be in when I bought the place just a few years ago.

In other words, holding at this point gets me a) a crazy huge tax bill or b) a possible rapid decline in property value, resulting in a loss of my paper gains. Guess I'm just looking for the upside, and I'm feeling rather nervous to be sitting on this much home equity.

[ShoulderThingThatGoesUp]

Even if you got taxed at 75% above $250,000, you'd still get more than $250,000. Avoiding gains to avoid taxes doesn't make sense.

That said, MMM's recent article about how you should probably sell something you wouldn't buy might apply here. Would you buy it, or in this market, would you just rent?

[LAGuy]

Even if you got taxed at 75% above $250,000, you'd still get more than $250,000. Avoiding gains to avoid taxes doesn't make sense.

That said, MMM's recent article about how you should probably sell something you wouldn't buy might apply here. Would you buy it, or in this market, would you just rent?

That would be true if real estate is the only game in town. But it's not. There's other places you can park your money that will let you avoid taxes.

The thing is, it's not just a 25% (24.3% to be exact) tax. Assume I maintain my current income of $100,000 a year. If I've made a profit of $100,000 over the $250,000 exemption then an Obamacare surcharge of 3.8% kicks in on everything over that. AMT kicks in as well to about the tune of 3%. So, now you're looking at about a 30% tax. Hold even longer, or hit the appreciation jackpot even more, say you're $300,000 over your exemption. Now, another 5% capital gains rate kicks in (AMT thankfully drops off) and you're over a 30% tax rate. After running the numbers on selling it seems like you either sell once you've hit your maximum exemption, or you hold the place FOREVER. I don't want to hold forever. I love LA...but it's a place to work. Not a place to retire in and I don't want to be an absentee landlord (or really a landlord of any sort).

I'm really not trying to humblebrag about my lucky property market timing. This wasn't what I had in mind when I bought. It was just cheaper then renting after running the numbers. Now, however, I have a place that I couldn't afford if I had to buy it all over again, that would rent for nearly $3,000 a month (about twice what I would pay myself and about 3 times my interest, HOA, taxes, and insurance payment), and now represents 2/3 of my net worth. I'm just wondering what others have decided to do in this situation? Just hold it and pay the tax bill at the end? Even if you're losing out big time on opportunity costs?

[AlexK]

I am in a similar situation with three rental properties. They aren't as valuable as yours but If I sold them there is no tax-free $250k allowance since not primary residence. My properties were good cash flowing investments when I bought them but have appreciated so much they are now duds for cash flow. Like you, I'm not complaining about this and I was lucky the appreciation happened, but it is a decision to be made nonetheless.

Being separate properties, I can sell them one at a time over a few years to minimize the income in any one year and therefore minimize the tax rate and that is what I plan to do. I am retired now so my income is low. Being married helps too.

A friend just sold a property for a huge profit (bought for $15k, sold for $130k after renovations) and he offered owner financing to spread the income over more years. Something to think about.

[brooklynmoney]

I am really interested in the feedback you get because I'm in your situation on the other side of the country. Bought in 2012 at bottom of market. My only problem is that if I sold I would have to leave the area, because, as one of our aspiring politicians proclaimed "the rent is too damn high." I would also have to pay the capital gains tax on the part of my gain that is above the limit and I already pay the AMT. That said, I heard you can do a 1031 exchange if you buy something else and can defer the taxes. Or I might just never sell this place and keep it as a rental when I leave. Have you thought about that? Just keeping it and using it as a rental if/when you leave LA? I don't count my residence in my net worth calculations, so I'm not really basing any plans on the gain.

[LAGuy]

Being married helps too.

You know, it's funny. I looked into the legality of marrying a friend so I could double up the exemption. It's actually perfectly legal to marry for tax purposes (turns out to be kind of the point of the whole thing, lol), but it's illegal to divorce for tax purposes! The real problem, though, is the "use test" i.e., you and your spouse have to have lived in the property for 2 of the last 5 years to qualify for the full $500,000 exemption. So unless you're prepared to either live with your friend for two years or lie about it and thus conspire to commit tax fraud, not really an option.

I am really interested in the feedback you get because I'm in your situation on the other side of the country. Bought in 2012 at bottom of market. My only problem is that if I sold I would have to leave the area, because, as one of our aspiring politicians proclaimed "the rent is too damn high." I would also have to pay the capital gains tax on the part of my gain that is above the limit and I already pay the AMT. That said, I heard you can do a 1031 exchange if you buy something else and can defer the taxes. Or I might just never sell this place and keep it as a rental when I leave. Have you thought about that? Just keeping it and using it as a rental if/when you leave LA? I don't count my residence in my net worth calculations, so I'm not really basing any plans on the gain.

Sure, I've thought about it. Place would make a good rental. Good location in the hip/happening part of town, sexy looking loft in an historic building (which qualifies it for a massive 60% property tax reduction), and most importantly includes a deeded parking space in a downtown area with only paid parking available. I just don't want the hassle of being an absentee landlord while FIRE'd. Plus, I need to establish residency in another state for maximum 401(k) withdrawl/rollover tax efficiency and having rental income in California might (?) complicate that process. My plan in FIRE is to travel the world as a nomad...having a rental really complicates not just the finances but frankly my dreams for retirement.

I'm thinking what I'll do is just stay put and otherwise turn on the afterburners on my retirement savings and hope to reach my FIRE number of about $750,000 ASAP. Figure I can get a bit more tax free cap space on my sale price by closing in a January if possible and then FIREing to keep my income down for that tax year.