Author Topic: Selling Rental House  (Read 3770 times)

Credaholic

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Selling Rental House
« on: February 13, 2015, 10:58:24 PM »
We're considering selling our rental house. It was a personal residence converted into a rental.

Purchased for $500K. Additional $75K put into remodeling.
Mortgage is $505,000. Interest rate is currently 2.75% (variable rate resets every year at LIBOR + 2.25%)
Monthly payment is $1675 (interest only loan until 2018, then ammortized over 20 years). Monthly rent is $2500.

I think we can get $625K for it this spring. We'll put a little work into getting it market ready (resod the front lawn, paint touch ups, etc.) and stage it, so maybe $5-10K to be safe. I'm considering offering it to our tenants for $600K now. I have no idea if that's feasible for them, but worth a shot? And I figure I can offer them the savings we'd get out of not having to list it.

We've taken $70K of depreciation on the property. I understand I would pay taxes on that amount. I hope I understand this right, but would I then also pay taxes on the net proceeds minus the basis? So $625K minus commissions, etc. - $575K. In which case it would really only be the depreciation recapture being taxed. We'd consider a better rental in the future, but with no concrete plan for that yet we wouldn't do a 1031 exchange.

Is selling this property the right thing? The market in our area is doing well, but I'm worried about another down turn having experienced that before, so I want to take advantage of it now. We're building a personal residence right now and would rather free up the equity in the rental than take out a construction loan. The rate is great, but that will change in the future, and we only have a few more years before the loan turns to P&I, at which point the payment will be way more than the rent.

I'm a little scared about kicking out the tenants, not having rent, and braving the market, but I think it's time to cut ties with this anchor. Curious if you all agree and if I'm calculating the taxes correctly (or missing any areas for tax savings!)

GuitarBrian

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Re: Selling Rental House
« Reply #1 on: February 14, 2015, 02:06:31 AM »
My understanding is this.

First calculate your cost basis.

500k (purchase price)
-70k depreciation

Things you are allowed to deduct from your yearly taxes, maintenance/repairs don't add to your cost basis.

Adding or replacing something that changes the value of the house can be added. Example, replacing the stove doesn't add to the value of the house. Putting in a pool does.

So resoding the lawn may of may not count, I am not 100% on the specifics.

+upgrades (75k hypothetical)

=505k

Then you take the sale price

625k
- expenses related to sale

=575k

70k in long term capitol gains.

Which are taxed depending on your income. If you have very low income... you will find a portion is taxes at 0%. And it goes up from there to 20% depending on your tax bracket. Also remember that state income tax generally does not differentiate for long term vs short. It all gets lumped together.


One last thing, if you lived in the house for 2 of the last 5 years, then it should be tax exempt. But you will need to look into that.

jmusic

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Re: Selling Rental House
« Reply #2 on: February 18, 2015, 10:46:59 AM »
One last thing, if you lived in the house for 2 of the last 5 years, then it should be tax exempt. But you will need to look into that.

The OP is correct that the depreciation recapture is taxable, despite the "2 in 5" rule. 

Credaholic

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Re: Selling Rental House
« Reply #3 on: February 19, 2015, 09:05:43 AM »
In the above example the LTCG worked out to exactly the depreciation. But what if for instance we were only able to sell for $575k?

OPP - Depreciation + renovations = 500-70+75 = $505k basis

SP - Selling Costs = $525k

So now LTCG is only $20k. Am I only taxed on this amount or am I taxed on the total depreciation amount?

Unfortunately the 2/5 rule doesn't apply to our situation, we haven't lived in it recently.

If we aren't able to get more for it, do you think it makes sense to keep the property a little longer? We still have 3 more years of potentially super low interest rates. I suppose we could wait and see what the market does in that time.

Bicycle_B

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Re: Selling Rental House
« Reply #4 on: February 24, 2015, 08:41:11 PM »
Commenters on Bigger Pockets, the landlord community sometimes mentioned by Mr. MMM, often recommend using the 50% rule for determining whether something is a good rental property.  It says that expenses which are not principal and interest will take up 50% of your rent, so never hold a rental unless P&I are 50% or less of the rent. 

$2500 rent x 50% = $1250.  Your current payment is above that, which suggests it's a good property to sell (risky property to hold) even with the low interest rate. 

Credaholic

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Re: Selling Rental House
« Reply #5 on: February 26, 2015, 11:55:24 AM »
Commenters on Bigger Pockets, the landlord community sometimes mentioned by Mr. MMM, often recommend using the 50% rule for determining whether something is a good rental property.  It says that expenses which are not principal and interest will take up 50% of your rent, so never hold a rental unless P&I are 50% or less of the rent. 

$2500 rent x 50% = $1250.  Your current payment is above that, which suggests it's a good property to sell (risky property to hold) even with the low interest rate.

I personally think that some circumstances/areas allow for being a little more generous than this rule, but despite that fact I think that the ARM and interest only nature of this loan is making it artificially look not as bad as it is, and I agree we shouldn't keep this property as a rental. But I also want to make sure we don't get killed by taxes, etc.

I believe we're only taxed on the actual difference between sales price and basis, and aren't taxed on the depreciation if the LTCG is less. If someone can confirm that for me, it would be appreciated!

I'm starting to think, however, that since we have good tenants and a little time with the low interest rate that perhaps we should get our ducks in a row for buying a better rental since long term that is what we want to do, and do a 1031 exchange to avoid taxes altogether. I think there's a link floating around here thoroughly explaining 1031 exchanges. I know they can be complicated. I haven't looked into what happens if you sell a new property purchased through a 1031 exchange. Do taxes look back retroactively to the original property?

zinethstache

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Re: Selling Rental House
« Reply #6 on: March 02, 2015, 02:35:29 PM »
In my opinion, if it is not a hair on fire emergency to unload it, you should try to save as much on taxes as you can. Now if you find the tax burden (that I see still hasn't been answered for you) is small, perhaps it's worth dumping it. The best source to answer what portion of your depreciation is taxable should be answered by a tax professional. Of course we all are waiting anxiously to hear the official answer, so please post what you find out!

Good luck!

jmusic

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Re: Selling Rental House
« Reply #7 on: March 02, 2015, 03:06:49 PM »
I believe we're only taxed on the actual difference between sales price and basis, and aren't taxed on the depreciation if the LTCG is less. If someone can confirm that for me, it would be appreciated!

NEGATIVE.  Depreciation "recapture" is a seperate issue from capital gain (appreciation).  It is taxable at ORDINARY INCOME rates.

From IRS pub 544, chapter 3:
http://www.irs.gov/publications/p544/index.html

Quote
A gain on the disposition of section 1245 property is treated as ordinary income to the extent of depreciation allowed or allowable on the property.

That said, don't be scared of the tax hit.  You should still sell it.  Maybe even do a 1031 exchange into a more suitable rental (get a good attorney if you go down that road).

clarkfan1979

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Re: Selling Rental House
« Reply #8 on: March 08, 2015, 12:40:17 PM »
It seems as thought selling it would be the most appropriate thing to do. The variable interest rate seems a little scary to me. However, I don't know much about it.