Say you bought a house for 500k and now it’s worth 1.05M. This is a good case to sell and pocket 500k gain tax free. But is it really worth it?
Your tax savings is about 36% of 500k: 180k
But you also incur costs:
Cost of selling: assume 50k.
After the cost of selling, you have 500k tax free gain. Then, you buy another house at the same price of 1.05M.
Is this a good deal?
Let’s look at property tax increases. Since your tax base has gone up about 500k, you’ll need to pay 6k extra property tax. In 30 years, that’s 180k extra tax payment. Of course this is future money so it should be discounted to today’s dollars. Assume the 180k extra property tax over 30 years is worth 90k in terms of today’s dollars.
So you saved 180k income tax, incurred 50k selling cost, and incurred an equivalent property tax expense of 90k. You total savings is only 40k.
40k saving is pretty small. Even worse, your capital gain is most likely not exactly 500k. If it’s larger, you’ll need to pay 36% tax on extra gain. If smaller, you’ll save less tax.
So is it really worth taking the 500k gains tax free?
I believe the same logic applies to 1031 exchange. But 1031 exchange might mean that you have a much better cash flow or other factors.
California does allow older people to keep their property tax basis, so the 90k equivalent propert tax increase is depending on age. But at that age, many people already have much higher gain.
This is a Calinfornia specific issue. I guess in other states it would make sense to sell whenever you have 500k gain.
Where else are you going to find any venture or job that allows you an upfront max 500K profit avoidance from tax? I have known people who did this eons ago serially, meaning doing rehabbing while living in the project home and selling it for profit (hopefully) and pocketing that money tax-free and then moving onto the next project home. Some, even had kids, so imagine the hassle of finding new school districts, etc. A lot of money was made, believe me, that is why there are more restrictions now around it in general.
Hard to say on that. There are obviously a lot of costs associated with holding properties. Not everyone has the time, resources or desire to hold onto properties. That is like saying house flippers don’t know what they are doing (by flipping) instead of keeping them and we know flippers the good ones are making money right?
So you agree that it’s better to hold instead of selling and taking 500k tax free when the owner is able to do so?
Flippers have many projects and they flip houses just like selling used cars. Because of their volume, they can potentially make a lot of money from flipping. But some flippers do flipping because they have no money to hold so they have to flip even though they wish to hold
You can’t get the $500k exemption if you’re truly flipping.
Keeping every property has limits. You usually need to rent it for 2 years before the income counts in DTI ratio, or they’ll count a discounted amount of rent. That means you can only acquire properties as quickly as DTI allows. You need funds for down payment for the next home.
I understand the financial limitations on how many properties people can afford. My point is to keep as many properties as possible, don’t sell houses solely for tax purpose since it may not be worth it.
Never sell and buy only should be the goal when possible.
This makes sense if the house you bought is lower value, and eventually you want to upsize. Your income may be sufficient for the larger house, but you may not have the down payment, no?
Why not? You borrow against equity of an existing property to buy another property. As long as you meet the LTV and DTI requirements, then there’s no issue.
If you buy 100k property and it jumps to 10 Million when your heirs inherit, they do not pay any capital gain when they sell it immediately. However, when the property is transferred to their name, it is valued at 10M level and property tax is on 10M.
There are ways to avoid it, create a trust, you be managing trustee and let them be your successor trustee.
Create a company and let the home is owned by that company. Company can be transferred to your heirs through will or Trust…etc