Author Topic: Case Study: Sell the Rental Property or Keep it (Help Needed!)  (Read 2622 times)

fishingman88

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So after reading through some of the Real Estate section, I am definitely not meeting the 1% rule by any means on the rental property I currently have so I'm pretty sure I the right decision is to sell the property, but I want to receive some feedback to ensure that I'm making the right decision.  I'm going to provide as many details as possible below in order to receive the proper feedback.

Details:

1) Purchased house in 2010 for $216,500.  Put down 20% ($43,300).
2) Lived in the house for 2 years.
3) Went to live in a SE Asia for a year and house was turned into a permanent rental property starting July 2013.

Additonal Details:

1) Mortgage Amount left is: $168, 298.  Mortgage payment is currently: $1027/month.
2) Mortgage Term and Interest: 29 years remaining at 3.75% (Refinanced last year)
3) Rent per month after management fees (too far away to manage property): $1426/month
4) Area is near a military base, so finding high quality tenants is very easy.  There is usually a maximum of 1 week in between tenants (1 week is for any repairs/cleaning)
5) Houses around the area are selling for around: $225-230K now, so house has appreciated in value.
6) Current tenant's lease is scheduled to end 4/30/2015.
7) Total Repair costs so far during current tenant's lease: $6650 (A/C repair, Fence re-build, A/C repair again, Ceiling Repair, Electrical repair) *Some freak accidents like lightning strikes resulted in A/C needing to be repaired.  Did the fence re-build because it was rotting out from previous owner who used cheap fence panels.
8) House was built in year 2003 FYI
9) Yearly HOA is $120
10) Depreciation for house will have been captured for roughly 2 years by the time the house can be sold.

I haven't sold a house yet, so I'm not 100% on what losses I will take other than the 6% sales commission (3% seller agent, 3% buyer agent) and the taxes on depreciation re-capture. 

At the end of the day, I'm assuming I'll lose a bit of the equity I put into the house which makes me sad, but I feel like I could invest that money and put it into a taxable account and invest in ETFs/Index Funds and come out ahead down the road (20 years).

Any advice from fellow property owners in whether I should continue forth with selling this rental property or keeping it would be much appreciated.  Thanks in advance fellow Mustachians.

johnhenry

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Re: Case Study: Sell the Rental Property or Keep it (Help Needed!)
« Reply #1 on: June 10, 2014, 12:56:01 PM »
I agree with your analysis.  I think you can do much better than this if you want to be invested in real estate that provides a better cash return.  The good news is, you may be able to sell this soon and meet the the IRS exclusion for capital gains on the sale of a primary residence.  http://www.irs.gov/taxtopics/tc701.html

If you can make the sale within 3 years of the date that you moved out, this will be the case.  If you moved for work relocation, you may want to check into the details of the rule.  If you lived out of the country, you may be able to claim that it was your primary residence all the way till July 2013.

If you can sell for a substantial gain and do it within the exclusion window, you should definitely do it!  This will avoid LT capital gains tax on the proceeds. That tax is 15% unless you are in the 10 or 15% tax bracket, in which case it's 0%.  If you are in the 10 or 15% bracket (and would be even with the expected gain from the sale), then selling to meet the exclusion isn't as important. 

You are correct.  When you sell you can expect to pay 6% commission unless you find a buyer.  But other seller's fees are negligible.  Because you claimed depreciation while renting it, you will pay tax on that recaptured amount at 25%, regardless of your tax bracket. 

If you can't meet the exclusion window for capital gains, and you still want to sell in the near future, then it becomes very important for you to calculate your cost basis in the property and compare that to what you expect to sell it for (minus the selling costs).  Your cost basis will include original cost + closing costs, along with any capital improvements while you lived there and while it was rented.

You have a good fixed rate on it, but I'd sell the place soon unless you intend to use it as a rental for the long haul.


waltworks

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Re: Case Study: Sell the Rental Property or Keep it (Help Needed!)
« Reply #2 on: June 10, 2014, 04:51:41 PM »
Once you account for fees and transaction costs, your tax hit will be negligible (remember, you are only taxed on the profits of the sale). I usually assume somewhere around 7 or 8% in fees (there are a few other things beyond the commissions you'll have to pay) so you probably will end up with

I would not think of selling the house as losing equity - think of it as losing an anchor around your neck! There's no way it's cash flowing at all (that's a grisly repair bill for last year, too) so unless you expect crazy appreciation, it's a terrible investment. Ditch it and if you end up with some money (I'd guess you'll have $30-40k in your pocket when all is said and done), great. If you just break even, c'est la vie.

-W

fishingman88

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Re: Case Study: Sell the Rental Property or Keep it (Help Needed!)
« Reply #3 on: June 11, 2014, 08:20:37 AM »
I agree with your analysis.  I think you can do much better than this if you want to be invested in real estate that provides a better cash return.  The good news is, you may be able to sell this soon and meet the the IRS exclusion for capital gains on the sale of a primary residence.  http://www.irs.gov/taxtopics/tc701.html

If you can make the sale within 3 years of the date that you moved out, this will be the case.  If you moved for work relocation, you may want to check into the details of the rule.  If you lived out of the country, you may be able to claim that it was your primary residence all the way till July 2013.

If you can sell for a substantial gain and do it within the exclusion window, you should definitely do it!  This will avoid LT capital gains tax on the proceeds. That tax is 15% unless you are in the 10 or 15% tax bracket, in which case it's 0%.  If you are in the 10 or 15% bracket (and would be even with the expected gain from the sale), then selling to meet the exclusion isn't as important. 

You are correct.  When you sell you can expect to pay 6% commission unless you find a buyer.  But other seller's fees are negligible.  Because you claimed depreciation while renting it, you will pay tax on that recaptured amount at 25%, regardless of your tax bracket. 

If you can't meet the exclusion window for capital gains, and you still want to sell in the near future, then it becomes very important for you to calculate your cost basis in the property and compare that to what you expect to sell it for (minus the selling costs).  Your cost basis will include original cost + closing costs, along with any capital improvements while you lived there and while it was rented.

You have a good fixed rate on it, but I'd sell the place soon unless you intend to use it as a rental for the long haul.

Thank you for the wonderful information on the exclusion for capital gains and also the calculation of cost basis.  I'm definitely pretty set in stone to sell the property now at the beginning of May after doing the calculations. 

fishingman88

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Re: Case Study: Sell the Rental Property or Keep it (Help Needed!)
« Reply #4 on: June 11, 2014, 08:30:46 AM »
Once you account for fees and transaction costs, your tax hit will be negligible (remember, you are only taxed on the profits of the sale). I usually assume somewhere around 7 or 8% in fees (there are a few other things beyond the commissions you'll have to pay) so you probably will end up with

I would not think of selling the house as losing equity - think of it as losing an anchor around your neck! There's no way it's cash flowing at all (that's a grisly repair bill for last year, too) so unless you expect crazy appreciation, it's a terrible investment. Ditch it and if you end up with some money (I'd guess you'll have $30-40k in your pocket when all is said and done), great. If you just break even, c'est la vie.

-W

Waltworks, I definitely agree with you.  I need to change my perspective to seeing this as an opportunity to lose the anchor and make a step forward in a better direction.  Appreciate the great advice.