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Selling or keeping a rental
Old 05-29-2016, 12:12 PM   #1
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Selling or keeping a rental

DW and I decided to try out being land lords and bought a ~1400 3bd/2.5 bath townhouse down the street from us (North San Diego) back in 2013. It's in a new complex (our unit was built in 2011) and it hasn't been much trouble, but we are tempted to cash out if it reaches a target price as it's been appreciating nicely. Has anyone done so and could you share your story, explaining what the tax consequences are and what we should look out for? I've tried to read up on it and the capital gains, depreciation claw back, yadda yadda has me confused. FWIW, we bought it for $345k, put $100k down, make $2300 in rent so it's officially in the black but I'd call break even cash flow since there is always something (two weeks without renters, broken washing machine, etc.). Right now comps are selling for $460k, which isn't enough to make it worth it in our eyes, but we're monitoring prices and could see it reaching a target we'd consider by this time next year. I understand we may get treated differently due to high income as well - we make ~$300-310k combined top line, I think AGI is still $250k+, I understand at $400k income something happens? Sorry if this is a beat to death subject, this is a new world to me, happy to read an old thread.
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Old 05-29-2016, 04:14 PM   #2
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You will pay long-term cap gains upon sale, but more importantly will have to pay back all the depreciation you deducted over the years. Did you or your CPA deduct depreciation?

You can use a 1031 tax-deferred exchange to avoid having to pay cap gains or depreciation by rolling the sale proceeds over into a like-kind property.

When we got tired of active mgmt and didn't want to pay for mgmt, we sold our condo in CA and rolled the proceeds over into 3 different DST (Delaware Statutory Trust) properties which pay us mailbox money with zero headaches and we clear more than we did by owning our property ourselves. A DST is a way to buy fractional shares of commercial properties with other investors. The properties are managed by professionals. We own small parts of triple net-leased retail properties with corporate guaranteed leases and also a multi-family apartment complex.

Until Title III of the JOBS Act is implemented, you must be an accredited investor to participate in most DSTs. This means you are worth more than $1M (exclusive of your residence) or have made $200K per year for the last two years and expect that to continue. I think you qualify on income, but you should verify yourself.

We are very happy with how this worked out for us. We can keep rolling over via the 1031 and the tax basis will be updated when the properties pass to our heirs. In the meantime, we get steady income of between 5 and 7 percent cash on cash return with expected IRRs in the low teens.

PM me for more info or the name of a good DST broker in LA.


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Old 05-29-2016, 09:59 PM   #3
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Thank you, I will talk this over with DW!
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Old 05-29-2016, 10:28 PM   #4
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I had a condo in the SFV that i rented from 2009 to 2014. When I got married in 2007, the market was too low to sell, so I rented it out. I had a management company, which made it easy.
But after having a tenant for 3 years, they moved out, and the rehab of the unit left me with a net of $400 for the year. I had one more one year tenant, and then said the heck with it.
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Old 05-30-2016, 12:13 AM   #5
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You better have taken depreciation but even if you didn't, the govt will still tax you on what you should have taken.

Say you sell early in 2017
2013 to 2016 depreciation for 4 years would have been about $50,000

You will owe tax of 25% on the recaptured depreciation $50,000 so that is = $12,500
pretend real estate fees and legal fees for sale are 25K
You will owe capital gains on 460K - 345K - (realestate fees and legal fees of 25K) = 90K

How much tax you pay on the 90K capital gains depends upon you other income, plus the $12,500 depreciation recapture.
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Old 05-30-2016, 01:07 AM   #6
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Originally Posted by Bruceski44 View Post
You will pay long-term cap gains upon sale, but more importantly will have to pay back all the depreciation you deducted over the years. Did you or your CPA deduct depreciation?

You can use a 1031 tax-deferred exchange to avoid having to pay cap gains or depreciation by rolling the sale proceeds over into a like-kind property.

When we got tired of active mgmt and didn't want to pay for mgmt, we sold our condo in CA and rolled the proceeds over into 3 different DST (Delaware Statutory Trust) properties which pay us mailbox money with zero headaches and we clear more than we did by owning our property ourselves. A DST is a way to buy fractional shares of commercial properties with other investors. The properties are managed by professionals. We own small parts of triple net-leased retail properties with corporate guaranteed leases and also a multi-family apartment complex.

Until Title III of the JOBS Act is implemented, you must be an accredited investor to participate in most DSTs. This means you are worth more than $1M (exclusive of your residence) or have made $200K per year for the last two years and expect that to continue. I think you qualify on income, but you should verify yourself.

We are very happy with how this worked out for us. We can keep rolling over via the 1031 and the tax basis will be updated when the properties pass to our heirs. In the meantime, we get steady income of between 5 and 7 percent cash on cash return with expected IRRs in the low teens.

PM me for more info or the name of a good DST broker in LA.


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That is amazing, I wonder if they have DSTs for businesses? Can you sell fractional shares strategically over time to pay little or no capital gains? Or is the money assumed to be locked up in the trust?
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Old 05-30-2016, 07:03 AM   #7
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Another option is this.

If you wanted to move to a different property someday, do a 1031 exchange into that property. Rent it for two years, then move into it. Even if you did not make money with the new rental, it may still be worth it.

After you buy it, fix it up the way you want it. All the costs will either increase the basis, or be a offset against any income you have as a business loss. It may save taxes that you would have had to pay.

After two years, move into it and call it your residence. When you pass, no tax. No gains. If you sell before you pass, you just recapture the depreciation at 25% and any capital gains that you would have to pay anyway.

A 1031 into farmland is an option. Or an Orange orchard.
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Old 05-30-2016, 08:21 AM   #8
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I consider a rental property as a source of income in retirement. After our expanses it generates about 4% return. Rental property is also a good hedge against inflation.
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Old 05-30-2016, 09:49 AM   #9
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The DSTs are illiquid with no secondary market. You're locked up until the sponsor exits, but it's a comfy cage.

A key tenet of the tax-deferred exchange is you must exchange into "like kind property." Residential rental real estate exchanging into commercial real estate is satsfactory. I suspect there's something like this for businesses but am not sure.


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Old 05-30-2016, 10:51 AM   #10
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Don't forget CA state tax. You will have to pay tax on the gain and the depreciation recapture.
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Old 05-30-2016, 02:21 PM   #11
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We've been taking the depreciation, our tax person explained it's the only rational choice. Thanks, I'll look at the Deleware thing but otherwise after taxes it's just not worth it to sell, it won't change our present lifestyle and probably hurts our long term FIRE goals. We took out a second to get the down payment so it's a rental bought entirely on margin, so to speak. I felt like I did my research and made a wise purchase but know I took a risk. The fact that it's cash flow positive and appreciating feels more like dumb luck ( I thought I'd get net a little better but still). So probably having realized I dodged a bullet has me wanting to lower risk, probably over correcting.
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Old 05-30-2016, 02:48 PM   #12
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We've been taking the depreciation, our tax person explained it's the only rational choice. Thanks, I'll look at the Deleware thing but otherwise after taxes it's just not worth it to sell, it won't change our present lifestyle and probably hurts our long term FIRE goals. We took out a second to get the down payment so it's a rental bought entirely on margin, so to speak. I felt like I did my research and made a wise purchase but know I took a risk. The fact that it's cash flow positive and appreciating feels more like dumb luck ( I thought I'd get net a little better but still). So probably having realized I dodged a bullet has me wanting to lower risk, probably over correcting.
That's how one one my relatives who used to live in a nice $3million dollar house in the beach area, had to move to a condo. They used equity of the first house to buy another house. Now they can't afforded it. Not sure what to tell you to do.
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Old 05-30-2016, 03:02 PM   #13
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We've been taking the depreciation, our tax person explained it's the only rational choice. Thanks, I'll look at the Deleware thing but otherwise after taxes it's just not worth it to sell, it won't change our present lifestyle and probably hurts our long term FIRE goals. We took out a second to get the down payment so it's a rental bought entirely on margin, so to speak. I felt like I did my research and made a wise purchase but know I took a risk. The fact that it's cash flow positive and appreciating feels more like dumb luck ( I thought I'd get net a little better but still). So probably having realized I dodged a bullet has me wanting to lower risk, probably over correcting.
So you could walk away with roughly $55,000 profit on $0 investment....
Or keep it and keep the risk, hoping your luck continues ?
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Old 05-30-2016, 03:09 PM   #14
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That's how one one my relatives who used to live in a nice $3million dollar house in the beach area, had to move to a condo. They used equity of the first house to buy another house. Now they can't afforded it. Not sure what to tell you to do.
I hear you, I had a friend do that to buy a total of seven houses, lost them all when the bubble burst. The total payment on the first house is still quite low, under $3k including impound account. Considering we gross $25k a month we were comfortable with the prospect of covering the mortgage on both places with no rental income, if it came to that. The risk was more about setting back our FIRE date if something did go wrong. At this point the both houses have healthy loan to value ratios (a little above or below 60%). But yeah, this was riskier than my normal comfort zone. I'll probably just monitor prices each spring and only be tempted to sell if they get to the point that everything could be paid off plus a nice chunk of cash in the bank, which won't be for some time, even in the rosiest of San Diego real estate predictions!
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Old 05-30-2016, 03:13 PM   #15
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So you could walk away with roughly $55,000 profit on $0 investment....
Or keep it and keep the risk, hoping your luck continues ?
No one went broke taking a profit, right? But with it being cash flow positive, I'm only looking at a potential paper loss. I do know that if I don't sell now I could be looking at being a landlord for a looong time, that's the risk/decision. And why I'm posting here, as my non ER friends all fall into two camps "I'd never be a landlord" or "SoCal real estate can only go up! 2007 will never happen again!"
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Old 05-30-2016, 03:17 PM   #16
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I will never be a landlord to a small house or town house. One of my management companies told me they refuse to rent out smaller home. Too much trouble. My experience with smaller home confirms that. People have to have excellent credit rating otherwise I let my house sit empty. It has not happened in the last 12 years yet.
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Old 05-30-2016, 03:44 PM   #17
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I will never be a landlord to a small house or town house. One of my management companies told me they refuse to rent out smaller home. Too much trouble. My experience with smaller home confirms that. People have to have excellent credit rating otherwise I let my house sit empty. It has not happened in the last 12 years yet.
Can you expound on that? What constitutes smaller? Square footage? Rental price? Three bedroom 2.5 baths and two car garage @ ~$2300-2500 seems like a fairly typical/average property, can you provide some harder parameters? Management companies I've talked to are happy to take my business...
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Old 05-30-2016, 03:52 PM   #18
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Can you expound on that? What constitutes smaller? Square footage? Rental price? Three bedroom 2.5 baths and two car garage @ ~$2300-2500 seems like a fairly typical/average property, can you provide some harder parameters? Management companies I've talked to are happy to take my business...
Usually starter home. I think like yours, less than 1700 square feet. The people that you rent to can technically get an apartment. You compete with apartment owners.
Essentially, the people who they have to deal with are not the high caliber ones. They have higher chances of ruining your house. If they do have high credit rating, they most likely buy than rent. There are exceptions of course.
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