Need to Consider a 1031 Exchange?
August 24, 2022
Buy Before You Sell
A common concern for homeowners is that if they sell their home first, they may not be able to find another home to buy. It is understandable with the low inventories currently available in most markets, but a strong argument can be made to buy your replacement home first.
In fact, there are some advisors that would tell you not to sell at all. Instead, keep the home for a rental investment and refinance it to pull out some cash for the down payment and closing costs for the new one.
Many homeowners recognize that their home has been an excellent investment for them. Their home may have outperformed their retirement and other investments. In all likelihood, homeowners understand the management and benefits of a single-family home far better than they understand stocks, mutual funds, annuities, or ETFs.
Just as there are low inventories of homes for sales, there are shortages of available single-family homes for rent, as is evidenced by rent continuing to rise. Rising prices and rents contribute to the rates of return that rental properties enjoy.
A homeowner, assuming they have good credit, can borrow the difference in their unpaid balance and 80% of the fair market value of their home. The proceeds are most likely not a taxable event and can be used to purchase the replacement home.
It is likely that the rent could cover the total payment on the refinanced former home. The seller, then, benefits from income, depreciation, equity build-up, appreciation, and leverage.
There is even a window of opportunity possible for the homeowner to rent it for a while, which covers his payment, allows the home to continue to appreciate, and then, sell and close it within two years and still be eligible for the section 121 exclusion of gain in a principal residence.
The homeowner may find that the investment is providing a better return than alternative investments and keep the rental beyond the two years. At some later date, if the homeowner wanted to dispose of the property and buy another more expensive rental, a section 1031 exchange may be available to avoid capital gains for a while longer.
Many economists feel that the low inventory situation in most of America is going to be a long-term event due to over a decade of underbuilding and maturity of the millennial generation. This will continue to propel both home values and rents; both of which are good for investors.
Buy before you sell but they don’t have to be at the same time; they can be years apart. Do a cash-out refinance on your current home for the proceeds to buy another home that meets your needs now. Then, convert your current home to a rental investment. Don’t wait because rising interest rates will increase your payments on not only the new home but the refinanced home also.Talk to your real estate professional about what the fair market value of your current home is now, what you can expect to pull out of it and what it would rent for. Download our Rental Income Properties guide for more information.