Sell a Rental Property?

[WageSlave]

I am an accidental landlord, in that I became a landlord due to life circumstances rather than deliberately investing in real estate for the purposes of renting it.  I mention this because, based on recent conversations here on this forum, I now realize that this house isn't really ideal for a rental.  This is mainly due to crazy-high property taxes: after those, plus manager commissions and other misc expenses, I only net about 40% of the rent.  This works about to be about a 3.3% "dividend" return on the purchase price.

My property manager mentioned that the current tenants have dropped hints that they might be interested in buying this house when the lease is up.  So, that combined with the mediocre profits makes me wonder if I should sell.

One big question I have: I vaguely remember hearing something along the way about, if I were to sell, having a liability to the IRS for the depreciation expenses I've claimed over the years?  If there's any truth to this, can someone point me to a reference?

Some other considerations:

• I have no idea what the house is worth now.  I bought it in 2004, and at the time it was only about four years old (i.e. only about 12 years old now).  Zillow thinks it's currently worth about 3% less than I paid for it (and I put some nice hardwood flooring in when I lived there, before it was a rental).
  
• My understanding of my taxes is that I currently pay no taxes on the rental income (yes, I shamefully admit to outsourcing my taxes, will address this at some point).  Basically, for the first two or three years I rented, I still had a mortgage.  That, combined with property taxes, depreciation, maintenance and commissions meant I ran it at a loss for several years.  That loss is being carried forward, and based on the amount, I won't owe taxes on this rental income for at least three more years.

On the one hand, as long as it stays rented, I feel I should not sell until I can at least break-even on the sale price (meaning after taxes and commissions are paid).  If Zillow is right, if I sold now, I'd lose money on the sale, especially after factoring in all the closing costs (and paying back the IRS for depreciation?).

On the other hand, if the current tenants move out for whatever reason, I have a vacancy risk that would only further erode my profits.  I think this is fairly minimal, as their lease is up in May, which should be as good a time as any to find tenants.  But you never know!

Basically just soliciting thoughts.

[freelancerNfulltimer]

To make an educated decision you need to hire an appraiser and/or get a Real Estate agent to pull comparable sales in your area. Zillow is not an accurate measure of your house's worth. Figure out what a reasonable sale price is for the property and then run the numbers.

[Another Reader]

Zillows estimates of value are a joke. Call two or three agents that routinely work in the neighborhood where the house is located and get some ranges of value plus some information on comparable sales and rents.  You have not seen the inside of the house, so you don't know the condition at this point.  A range of value is what you can expect without knowing the condition.

Yes, you will have to recapture depreciation if you sell.  If you have carry forward losses, they should offset some or all of the recaptured depreciation. 

In your shoes, I would start an extensive information gathering process now.  What are current market rents in the area?  Is the neighborhood desirable to renters?  What is the average length of vacancy?  Is the assessed value accurate and equalized and can you appeal the assessment if it is not?  What condition is the house in?  What work will need to be done to re-lease or sell it?  If it makes sense to sell and re-invest the proceeds elsewhere, are the current tenants qualified to buy the house?  How long would it likely take to sell the house if you listed it?

Once you have gathered all the information, you will be in a much better position to make a decision to sell or hold the property.  I would not make a sale decision based solely on whether I would incur a loss.  In your shoes, I would look at how much I could net from a sale, and if I would be more successful holding the current property or re-investing the net proceeds elsewhere.

[bdub]

On the one hand, as long as it stays rented, I feel I should not sell until I can at least break-even on the sale price (meaning after taxes and commissions are paid).  If Zillow is right, if I sold now, I'd lose money on the sale, especially after factoring in all the closing costs (and paying back the IRS for depreciation?).

The way you feel feel should have no impact on this decision.  This is a purely financial decision and what you paid in 2004 is water under the bridge.  Deciding to sell of keep should be based on the current financials.

Clarification question:  is the 3.3% "dividend" based on the purchase price or your investment in the home?  Example:  Gross of $3300 on a home that had a purchase price of 100K is 3.3% BUT a gross of $3300 on a 20% down payment on a 100K purchase price is a 16.5% return (3300/20K downpayment = 16.5%).  Your calculation should be based on what you have invested in the home.  If you are getting 16.5%, I would NOT be selling.  If you are getting 3.3% on your down payment (in the previous example, this would be $660), I would sell.

[WageSlave]

The way you feel feel should have no impact on this decision.  This is a purely financial decision and what you paid in 2004 is water under the bridge.  Deciding to sell of keep should be based on the current financials.

Agreed.  I guess I should have said, "I want to maximize the return on my investment" rather than "I feel..."  That's what I meant anyway.  :)

Clarification question:  is the 3.3% "dividend" based on the purchase price or your investment in the home?  Example:  Gross of $3300 on a home that had a purchase price of 100K is 3.3% BUT a gross of $3300 on a 20% down payment on a 100K purchase price is a 16.5% return (3300/20K downpayment = 16.5%).  Your calculation should be based on what you have invested in the home.  If you are getting 16.5%, I would NOT be selling.  If you are getting 3.3% on your down payment (in the previous example, this would be $660), I would sell.

It's based on the purchase price of the home.  I paid off the mortgage a few years ago, so what I have invested is that plus the interest I paid while I had the mortgage plus the cost of the hardwood floor upgrade.  But I base the 3.3% off what the seller and I agreed to back in 2004.

Another Reader: thank you for all the feedback.  I totally agree, I simply need to gather a lot more information.  You list lots of factors that I hadn't even thought about.  Very helpful.

[arebelspy]

Depreciation recapture will reset your cost basis (google either of those terms for more).

Simplified example:
You pay 100k.  You claim 25k depreciation.  You sell for 100k.  You want to say you broke even on that place, the IRS says you gained 25k on it (that it is equivalent to you buying the place for 75k, your cost basis of purchase price - depreciation, then selling for 100k).  Of course other factors are included in cost basis, that's a simple example, but may help.

Instead of selling right away, you could lease option or lease purchase it to the tenants and that will save you management fees, and you could make them cover all maintenace while they keep paying you until they buy!