To Sell or No To Sell

Posted by urbandigs

Mon Jan 29th, 2007 10:09 AM

A: I wrote this post for the Yankee Blog swap that I had with Kris Berg over at the San Diego Home blog, but decided it was time to publish it here after having a conversation with a client about whether they should sell or not. When making the ultimate decision to sell or not, you MUST understand your own personal situation both financial and other before making a decision. Believe it or not, there are wrong reasons to list your apartment for sale, especially if you will owe a hefty tax bill because you don't meet the primary residence tax benefits or 1031 exchange requirements.

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I want to briefly go over the two most popular types of tax benefits that real estate investors can cash on when they report a gain, as failure to achieve either benefit could be reason NOT to sell your home:

1. PRIMARY RESIDENCE OWNERSHIP & USE TESTS (Out of 5 YR Period)

  • Owned the home for at least 2 years (the ownership test), and


  • Lived in the home as your main home for at least 2 years (the use test)


  • 2. 1031 Exchange ('Starker' Exchange)

    Allows a tax payer to defer the paying of taxes on a gain when an investment property is SOLD & a new property of like or greater value is PURCHASED. In other words, if you first purchased a property for $400K, and then 1 year later sold it for $500K, you can then defer the payment of taxes on the $100K Capital gain in this transaction, as long as you purchase another property worth $500K or more.

    Now, lets get right into selling for the right reasons.

    REASONS TO SELL

    Relocation - If you are being relocated for work, or plan on moving permanently, than making the decision to sell is no decision at all. Price your apartment aggressively based on the last comparable sale in your building or neighborhood, and list your property now. Don't wait to see where you might be headed or to see if the housing market might turn around in the near future, because chances are it will take longer than you expect to get a bid that is acceptable to you.

    Need To Upgrade - If you have outgrown your property and need more space, buying an upgrade is a very good reason to sell. If you dont qualify for the USE & OWNERSHIP tests that are required for the main primary residence tax benefits of your gain, you can use a 1031 exchange to buy a property of LIKE or GREATER VALUE than your sale and DEFER tax payments on the gain until the next sale. Buying an upgrade is a necessity, not a luxury, especially if your family is growing and space is tight in your current home!

    QUICK TIP: It's always better to SELL first before signing any contract on your new home. While I am a firm believer of knowing product knowledge and being comfortable with the available inventory that you might be buying into, I worry that your home may not sell as quickly as you think; especially if you test the market and price high. Keep in mind the possibility of paying 2 mortgages if you decide to buy first, and whether or not you can weather that kind of financial storm.

    Financial Hardships - If you bought more than you can chew, or experience a pay cut or layoff, than you should seriously consider selling your home. The worst thing you can do is to pull money out of your home just so you can continue to get by! Wasting equity in your home is like wasting money on unnecessary luxury's. It's just not a smart financial decision.

    If you find yourself increasing your bad debts (i.e. credit card debt or taking out a HELOC to afford your current lifestyle), than sit down and seriously consider cashing out your home and paying off these debts to regain your financial independence. Chances are you still have some great equity left in your home and cashing out a hefty gain to avoid bad debts will never be the wrong move. Suck it up and rent for the short term until your luck improves and your income gets back on track! If your not making it, then stop spending it!

    Plans To Sell In Near Future - Assuming you qualify for tax benefits, if you were planning on selling your home within the next 12-24 months, you might be best listing your apartment for sale now, rather than later. The housing market is a market like any other and as such does have its ups and downs. Because of its illiquid nature, that is that doing a real estate transaction takes time (unlike a stock trade), once the housing market turns from its peak it may be years before a bottom is realized. Right now we are still searching for a bottom that could be many years away!

    REASONS NOT TO SELL

    No Tax Benefits - One reason why investing in real estate proves time and again to be a savvy long term investment is because of the tax benefits afforded to the buyer both in monthly tax deductions and exemptions in gains at resale. If you don't meet the primary residence tax benefits requirement and you do not intend to buy a new property of like or greater value, than you MUST talk to your accountant to see if selling is the right choice.

    I almost had a sales client that was thinking of downsizing and selling her 4BR home and buying a 2BR home to cashout and keep the difference. Only one problem. She only would get a 250K exemption from capital gains on what would have been a $1.7M profit or so since she bought the home 35 years ago. Thats $1.4M or so of taxable gains and her accountant advised her that a tax bill of $300,000-$350,000 would be due the following tax year. If she sells for $1.7M, then buys a $900K-$1M property, after taxes she would have very little left. The numbers just didnt make sense. So, do yourself a favor and crunch the numbers and ask your accountant what tax benefits you will get or not get by selling your home.

    Can Afford Rental Investment Strategy - If you are able to afford to hold onto the property and rent out for investment income, than do it. Even if you are only getting 85% or so of the total cost of the property back in rental income, I still think it is worthwhile to keep this income producing asset in your portfolio. However, if you are highly leveraged with a number of rental properties and too much exposure to real estate in your total portfolio, it might be best to sell 1 or 2 of the lowest performing properties and lower your exposure to the real estate sector for a short while. Talk to your financial advisor about this in more detail if you are in this situation.

    To Increase Quality of Life - If your only reason for selling is to be able to afford more vacations, or a wedding, or a car, or some other type of temporary luxury, than you are selling for the wrong reason. We Americans are a spoiled bunch. We like to spend when we should be saving. The equity in your home is no different. Too many people have used their homes as ATM's over the past years and lowered the equity they now own in their home. Do yourself a favr and make the right decision. Don't sell and hold onto your home equity for a real rainy day or bigger payoff down the road when the housing market turns around again!

    You Found A Incredible New Home
    - I'll keep this short and quick. If you are super rich and could afford it, fine, go for it. But assuming you work hard for your money and like most people, have to work even harder managing it, than keep EMOTION OUT OF YOUR HOUSING DECISIONS! I'm not saying don't buy the home you fall in love with. I'm saying don't sell your home now because you found an inredible new home, that is much bigger and much more expensive that you normally would buy!

    Too often I see buyers reaching way beyond their budgets to buy a home that is $100K, $200K or sometimes $300K more than their actual budget. In this day and age, even the worst credit history's can get a huge loan. So, you must exercise discipline and learn to not fall in love with any new home, especially if you can't afford it!

    Selling your current home to get the cash to buy the home of your dreams is a big no-no! Trust me, you don't want to sacrifice quality of life to live in a incredible home that could very well be the spark to a financial fire!


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