Sell/rent? Tax treatment of rental income and mortgage/HELOC expenses

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riverway4
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Joined: Mon Nov 08, 2021 3:40 pm

Sell/rent? Tax treatment of rental income and mortgage/HELOC expenses

Post by riverway4 »

My family lives in a small condo in a VHCOL area. We bought for $300K in 2010, renovated for another $300K, and through appreciation it's now worth about $1.1M, with a remaining mortgage of $170K at 2.35% ($1.2K monthly payment), so we have ~$900K equity locked up in the condo.

It's only 1400 sq ft and we now have three kids, so we would really like to upgrade to something larger. The current interest rates make the marginal cost of a larger place significantly more expensive, but we are likely to move forward anyway because the timing is right for our family and interest rates could be high for a while (or if they go down, we can refinance).

We are considering renting our condo out when we buy a new place, and I'm trying to figure out the tax implications of that choice. I think it would rent for ~$4.5K per month. I assume that the mortgage payments that we would continue to make, condo fees, insurance, and taxes would all be deductions from our rental income (total about $1.8K per month, leaving $2.7K in net income). Could we take a HELOC out on the current condo, use that money to make a down payment on a new home, and deduct the interest from the HELOC as a rental property expense? Or do a cash-out refinance (unappealing because we'd lose our 2.35% rate, but could potentially transfer some interest expense from new property to rental property)?

Or should we sell soon rather than rent since we're basically at the $500K cap for tax-free capital gains exclusion? We could rent it out for up to 3 years and still keep the $500K exclusion, so perhaps we would only want to consider short-term renting? Or do you think that given the low interest rate locked in on that loan, renting it out for a longer time could make sense?

We have enough savings that we can make a 20% down payment on a larger home (looking in the $1.6-$1.8M range), but it becomes a very large loan unless we add equity from our current home (either through selling it or taking a HELOC). Our HH income is in the $350K range, in case that's helpful context. Thanks for any advice!
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