Morris

Sirrach,
You have to do it right, and not have access to the cash. (many rules here). Also it's not tax free, it's tax deferred.

under-rated

I suggest you purchase it owner occupied... who cares if you don't occupy the residence, just claim it as a personal I do it all the time. What they don't know won't hurt. . . The rule of thumb on capital gains is that as long as the property has been a primary for at least 2 years within a 5 year period of time you don't have to pay capital gains.

20% down isn't always necessary, some lenders will finance investment purchases with as low as 5% down. The idea is to hold on to your cash. Lastly I would secure an ARM because of the limited duration . . .

bjohnston

Thanks for all the replies. Clearly, I need to consult with a tax advisor if this is something I move ahead with. I did some brief research on realtor.com looking for townhouses out in Gainesville, VA, which is basically the westernmost VA suburb of DC, and found that new townhouses started closer to $325K. They've gone up quite a bit since I last looked. At those prices, 20% is closer to $65K, which is a pretty hefty sum. From what I understand, lenders usually like to see at least 20% down when the property is an investment property. Am I right in that assumption?

under-rated

You are right. However like I mentioned, there are lenders that will conventionally finance an investment property with as little as 5% down. Why don't you buy it as a vacation property, it only has to be 60 miles away from your primary residence. Hold your dough.

Pakisho

As Morris said, you can deduct the interest. At least here in CA you can. Maybe its a state to state thing?

Keep in mind, however, that if you are not in the field of real estate and you earn above a certain bracket, there is a limit that you can deduct (sorry I cant be more specific, memory is hazy on this and its never applied to me).

You CAN go for the loan intending to occupy the property as your primary residence. This will get you a break on both the actual numbers, and the amount of hoopla you have to go through during the approval process. If you decide not to move in later, it doesnt really matter. But I would be very careful about actually claiming that you lived there for two years, tax wise. Sounds very risky to me.

And yes, a 1031 exchange is possible-sell the investment property, and then within a finite period of time invest the proceeds into another property/properties. Tax free.

Good luck! And keep in mind that unless you've found a real hotspot (Las Vegas in the recent years springs to mind), you may not have huge gains. Find someone willing to cut you a break on the transaction (I routinely do it for clients of mine, as long as they come back to me for future needs), and you could get out of it with a reasonable chunk of equity.

2002S2K

Your plan sounds good, yet I don't know if these particular issues have been touched on...

1. How easy is it to find a renter there, how much vacant time can you expect?...When you are putting out 2.5k a month rather than bringing in $300-$500 as you said

2. When you go to sell, you are going to use a broker or do sale by owner, that will also take a large chunk if you go with the broker.

3. Renter selection - you had better choose a perfect renter if you are only going to be there 2 years, if they trash the place, then you could be in serious trouble and lose some of the appreciation on the property because of the diminished value of the townhome itself.

4. If you buy a 2-family and you lose one renter, than you still have half the income of the property, if you lose the renter in this unit, there is nothing. Being a single family dwelling is inherently riskier than a multiple family dwelling.

Morris

Just to clarify a point- a 1031 exchange allows you to take the money from one piece of property and acquire another and defer the tax till you sell the new property (or exchange it and defer again). But you cannot sell the property, put the money in your bank account, then decide you really didn't want to do that and go find another piece of property to invest in, and avoid paying tax on the sale. YOU WILL OWE THE TAX. These rules are complicated and if you touch the money, or have access to it, you are screwed.
This is a simplified response- see your tax advisor for complete rules as they might apply to your situation. (A cover-my-ass disclaimer)