Author Topic: Middle of the Night Aha! on Rental Property? Help me think this through.  (Read 4583 times)

onemorebike

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I've talked about my rental here before but had a thought in the middle of the night - mostly spurred by conversation here - that I was wondering if folks could help me think through.

I'm considering selling it and using the profits to pay down other debts, in effect increasing our income since we wouldn't be paying to those sources each month and then not having the hassle of being a landlord, worrying about major repairs or the rent not showing up on time. (which incidentally, I do rather well, but not sure the current "profit" other than the investment itself are worth it)

The rough number are something like:

I bought rental for 105000 with mortgage at 5% and monthly payments around $740 (in a pretty well placed neighborhood to downtown Denver that will probably appreciate well over the next 10-20 years) and rent it for about $1250. So, we make about $6,000 a year (before taxes) and pay down 2500 a year in principal (and growing) by having a renter.
Worth probably $165000 if I sold today due to about $20,000 in repairs and comps show at $165,000.
The reason I am considering selling now is I'll pay something like an additional $8,000 if I were to sell a year from now because I'll then owe capital gains per the 2 out of 5 year residency rule and a very good tenant is moving out in October. It seems like a good time to at least consider the option.

We live in a second house that is about $205,000 at 4% ($1250 a month)
and have school loans of about $20,000 at %4.0 - ($300ish a month) after a pay down I'll make this month.

So, would it be more valuable to sell the rental now, apply the $50,000 or so in profit to the school loans and the current mortgage to reduce/eliminate those payments? I feel like with the tax on the rental profits and the inevitable repairs the only investment there is the hope that it increases in value while we pay down the mortgage with a renter - but feel like this, as I've mentioned before, is just paying me to be a landlord - which could be increasingly difficult depending on my next tenant.

It should be said, we got into the rental game because we saw it as essentially a college/retirement fund that would take some fluffing (me working as a landlord, dealing with stress of second home) but maybe paying down those other debts and investing the addition $500 or so a month saved from not paying the second mortgage and school loans would be a better approach?

Any thoughts on this process would be helpful in thinking through this important decision.


Another Reader

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Re: Middle of the Night Aha! on Rental Property? Help me think this through.
« Reply #1 on: January 08, 2013, 10:14:12 AM »
Before you spend a lot of time on the numbers, consider who the likely buyer is.  If it's an owner occupant and the property is occupied under lease until October, that buyer will not buy your house today.  That would leave you with a much smaller pool of investor buyers, most of whom probably would not like the income numbers at market value.  The tenant has to be within a couple of weeks of vacating and cooperative about showing the property to get any interest from owner occupant buyers.

onemorebike

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Re: Middle of the Night Aha! on Rental Property? Help me think this through.
« Reply #2 on: January 08, 2013, 10:17:48 AM »
You make a good point, and something I should have clarified - I'm thinking I would follow through on this decision in October, when the lease was up, but I'm just thinking about it now. I'd be looking to sell an empty house (the way the renter has this small house stuffed with crap it would take a LONG time to sell. :) ) in October.

Before you spend a lot of time on the numbers, consider who the likely buyer is.  If it's an owner occupant and the property is occupied under lease until October, that buyer will not buy your house today.  That would leave you with a much smaller pool of investor buyers, most of whom probably would not like the income numbers at market value.  The tenant has to be within a couple of weeks of vacating and cooperative about showing the property to get any interest from owner occupant buyers.

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Re: Middle of the Night Aha! on Rental Property? Help me think this through.
« Reply #3 on: January 08, 2013, 10:26:12 AM »
It's hard to make a decision about harvesting the gain in this situation.  If you hate being a landlord, then you should get out of the business.  If not I think the tax sheltered income or the accrued loss if you can't take the deduction should be considered.  If you have this asset largely paid off and it has appreciated substantially at the time he kids are ready for college, you have the option of selling or refinancing to help them.

smedleyb

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Re: Middle of the Night Aha! on Rental Property? Help me think this through.
« Reply #4 on: January 08, 2013, 11:27:14 AM »
If your goal is to pay off debt, sell the house and move into the rental.

If your goal is to build long term wealth, keep the rental and the house and look to pay off your debt via aggressive frugality.  Use profits from rental (get a line of credit open too)  to buy more rentals, etc.  A good accountant worth her salary will make sure you never pay a dime in tax on rental income. 


 

arebelspy

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Re: Middle of the Night Aha! on Rental Property? Help me think this through.
« Reply #5 on: January 08, 2013, 12:17:28 PM »
The reason I am considering selling now is I'll pay something like an additional $8,000 if I were to sell a year from now because I'll then owe capital gains per the 2 out of 5 year residency rule and a very good tenant is moving out in October.

You realize the original 2/5 rule was gotten rid of in 2009, and now it's a prorated amount?

Is that 8k the prorated amount?

From this site: www.groco.com/readingroom/real_helpforhomeowners.aspx
Quote
“Non Qualified Use” Provision
There is another new provision in a bill passed by Congress that will take effect January 1, 2009 that you need to know about. This involves rental properties that revert back to owner-occupied properties.

Old Rule: Rental > Owner-Occupied > Live in 2 out of 5 years > Sell and get $250,000 capital gains tax free if single, $500,000 if married.

New Rule: Rental (let’s say for 3 years) > Owner-Occupied > Live 2 out of 5 years > Sell – now the government says the 3 years of rental were “non-qualified” use so you will only get credit for the years that were owner occupied, or in this example: 2/5th of the gain is tax free. There is a formula: the top number is the amount of time it was owner-occupied and the bottom number is the time of total ownership of the property, this fraction then determines the amount of tax free gain and the balance that will be taxable up to the $250,000 or $500,000 limit.

Why is this important? If you own a rental or plan to buy one and then plan to revert it back to a principal residence at some point in time, you need to be aware that you will not be getting 100% of the taxable gain credit up to the $250,000 or $500,000 limit. You will only be entitled to a portion of it tax free, with the balance being taxed. Have a CPA help you with this if you are thinking of doing this or are in this situation.

That is the first google hit.  I'm sure there's more.
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Re: Middle of the Night Aha! on Rental Property? Help me think this through.
« Reply #6 on: January 08, 2013, 12:42:14 PM »
Arebelspy:

You are pretty much correct, except for some situations involving ownership before 2009.  See IRS Publication 523 pps 15-16 for the very confusing details/example.  But generally, non-qualified use means not all the gains are excludable.  The OP should look at that publication and then run it by his tax professional.

Nords

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Re: Middle of the Night Aha! on Rental Property? Help me think this through.
« Reply #7 on: January 08, 2013, 01:22:45 PM »
Any thoughts on this process would be helpful in thinking through this important decision.
You're the first landlord I've ever read who came up with an exit strategy and a timeline. 

I think most landlords talk about it, but their strategy/timeline ends up being "probate"...

If you're not absolutely fascinated with the idea of being a landlord then get out of the business.  Put it on the market (during the crazy popular summer buying season) to see if a landlord will buy you out for the cashflow.  If that doesn't work out then by the time the tenant is gone you'll know what you need to do to shift your sell strategy toward the owner/occupant.