For all our inner engineers, here's a real-world rent vs sell question with lots of numbers. I'd appreciate a critique of my logic and my math.
A couple months ago spouse and I spent 26 consecutive days rehabbing our rental. We juggled three contractors and did our own HGTV "Groundbreakers" yardwork so it was great exercise but not much fun. For the last five years it's been rented to my parents-in-law, who we thought would be living in it for the rest of their lives-- our long-term care gift. I expected to depreciate it for two more decades and we may still do that. However now that the PILs have returned to the Mainland the property has essentially been dropped back into our laps. It was never part of our ER planning, and it's slowly dawned on me that we've won the real estate lottery.
I wasn't very interested in landlording strangers again, but the same rehab effort (yardwork, ceilings, carpeting) would have been necessary for seller's curb appeal. Tenants just dropped into our laps, too (federal GS-12, shipmate of shipmates) and they signed a year's lease. At Hawaii's home prices I doubt they're moving.
Spouse's attitude was "There now (pat pat), that wasn't so bad, was it?" while my reaction has been "Run away fast!" However the decision is in abeyance for the lease so now I have plenty of time to figure out exactly what our cash-on-cash return is and what our after-tax profit would be.
Help me make sure that I have the math right. I've been reading IRS Pubs 527 (rental property, http://www.irs.gov/pub/irs-pdf/p527.pdf) & 544 (asset sales, http://www.irs.gov/pub/irs-pdf/p544.pdf), and punching numbers into TurboTax.
We bought the property in 1989 for $277K (with a huge mortgage and a dumpster of sweat equity). While we were living in it we pumped in another $82K (including closing costs, refinancing, & house/landscaping improvements) to raise the basis of the land & house to $359K. I've kept receipts and tracked that number in Quicken so it's solid.
We depreciated the house (not the land!) on 27.5-year MACRS at the basis of fair market value-- $152K from the tax assessment. So far we've depreciated $52K.
The neighborhood's prices are obscene-- it's assessed at $628K. In round numbers a FSBO would fetch about $700K after closing costs. Our cap gains would be $700K - $359K = $341K. In addition we'd have $52K of depreciation to pay recapture taxes on.
Let's assume that before we sold the house we were already at the top of the 15% income-tax bracket. (I'm not sure it's relevant but with our Roth IRA conversions that's usually the case.) If I'm correct on the tax rates, we'd owe cap gains taxes of 15% on $341K and 25% on $52k, so our total tax bill would be $64,150 (call it $65K).
We have a mortgage balance of $135K, so after taxes we'd walk away with $700K - $65K - $135K = $500K. I'd call that our equity.
The neighborhood's rent is also obscene, $2800/month, and our carrying costs are typically $1300/month. (That's mortgage, excise taxes, property taxes, income taxes, and $850/year for maintenance & repairs.) So our net is $1500/month or $18K/year. Dividing that into our cash in the house ($359K-$135K) is a cash-on-cash return of 8%. Dividing it into our equity is only 3.6%, which we can beat with just about any long-term after-tax CD rates.
After 18 years our net profit is $500K - $359K = $141K, or about 1.9%/year. We bought at the top of the market and watched it go through a decade of bear before it's come back up to its current value. Although there wasn't much annual capital gain, we'd also have to factor in all the rent profits ("dividends") over the years.
Ironically we could move back into it for a couple years before selling and avoid $52K of taxes on the $341K. Our opportunity costs (lost rent receipts) would be more than that, we'd have to rent out our dream house, and moving would be a colossal hassle that would never meet with spouse approval. In other words you couldn't pay her $52K to go through that for two years & two moves.
This decision has an emotional as well as a financial aspect. We did start our family there. We never really wanted to be landlords but during a mid-1990s military transfer it was "easier" than trying to sell into a depressed market. When we bought our dream house a few years later it was "easier" to rent out the old one than to sell it. A few months after that spouse's parents called and ended any thoughts of selling... until now. However there's still the question of "saving the property" for the next generation, who's at least 10 years away from being able to avail herself of that opportunity. Even then I doubt she'd want to be living in the house she grew up in, especially if she can [-]get her own life[/-] find her own place. I wouldn't want to just hand her a house and rob her of her own sweat-equity experience!
The last 18 years have been a real testament to leverage & sweat equity. If loans weren't so cheap and credit so easy to get then we never would have become landlords. I have no desire to expand our empire, either, and personally I can cash out with no regrets. If we wanted to "save" something for our kid then I think TIPS or I bonds would do just as well as real estate, to say nothing of a small-cap value equity index or an international REIT.
Am I missing anything on the numbers, tax rates, or depreciation recapture?
I'm clueless on AMT-- is there anything here that would trigger it?
A couple months ago spouse and I spent 26 consecutive days rehabbing our rental. We juggled three contractors and did our own HGTV "Groundbreakers" yardwork so it was great exercise but not much fun. For the last five years it's been rented to my parents-in-law, who we thought would be living in it for the rest of their lives-- our long-term care gift. I expected to depreciate it for two more decades and we may still do that. However now that the PILs have returned to the Mainland the property has essentially been dropped back into our laps. It was never part of our ER planning, and it's slowly dawned on me that we've won the real estate lottery.
I wasn't very interested in landlording strangers again, but the same rehab effort (yardwork, ceilings, carpeting) would have been necessary for seller's curb appeal. Tenants just dropped into our laps, too (federal GS-12, shipmate of shipmates) and they signed a year's lease. At Hawaii's home prices I doubt they're moving.
Spouse's attitude was "There now (pat pat), that wasn't so bad, was it?" while my reaction has been "Run away fast!" However the decision is in abeyance for the lease so now I have plenty of time to figure out exactly what our cash-on-cash return is and what our after-tax profit would be.
Help me make sure that I have the math right. I've been reading IRS Pubs 527 (rental property, http://www.irs.gov/pub/irs-pdf/p527.pdf) & 544 (asset sales, http://www.irs.gov/pub/irs-pdf/p544.pdf), and punching numbers into TurboTax.
We bought the property in 1989 for $277K (with a huge mortgage and a dumpster of sweat equity). While we were living in it we pumped in another $82K (including closing costs, refinancing, & house/landscaping improvements) to raise the basis of the land & house to $359K. I've kept receipts and tracked that number in Quicken so it's solid.
We depreciated the house (not the land!) on 27.5-year MACRS at the basis of fair market value-- $152K from the tax assessment. So far we've depreciated $52K.
The neighborhood's prices are obscene-- it's assessed at $628K. In round numbers a FSBO would fetch about $700K after closing costs. Our cap gains would be $700K - $359K = $341K. In addition we'd have $52K of depreciation to pay recapture taxes on.
Let's assume that before we sold the house we were already at the top of the 15% income-tax bracket. (I'm not sure it's relevant but with our Roth IRA conversions that's usually the case.) If I'm correct on the tax rates, we'd owe cap gains taxes of 15% on $341K and 25% on $52k, so our total tax bill would be $64,150 (call it $65K).
We have a mortgage balance of $135K, so after taxes we'd walk away with $700K - $65K - $135K = $500K. I'd call that our equity.
The neighborhood's rent is also obscene, $2800/month, and our carrying costs are typically $1300/month. (That's mortgage, excise taxes, property taxes, income taxes, and $850/year for maintenance & repairs.) So our net is $1500/month or $18K/year. Dividing that into our cash in the house ($359K-$135K) is a cash-on-cash return of 8%. Dividing it into our equity is only 3.6%, which we can beat with just about any long-term after-tax CD rates.
After 18 years our net profit is $500K - $359K = $141K, or about 1.9%/year. We bought at the top of the market and watched it go through a decade of bear before it's come back up to its current value. Although there wasn't much annual capital gain, we'd also have to factor in all the rent profits ("dividends") over the years.
Ironically we could move back into it for a couple years before selling and avoid $52K of taxes on the $341K. Our opportunity costs (lost rent receipts) would be more than that, we'd have to rent out our dream house, and moving would be a colossal hassle that would never meet with spouse approval. In other words you couldn't pay her $52K to go through that for two years & two moves.
This decision has an emotional as well as a financial aspect. We did start our family there. We never really wanted to be landlords but during a mid-1990s military transfer it was "easier" than trying to sell into a depressed market. When we bought our dream house a few years later it was "easier" to rent out the old one than to sell it. A few months after that spouse's parents called and ended any thoughts of selling... until now. However there's still the question of "saving the property" for the next generation, who's at least 10 years away from being able to avail herself of that opportunity. Even then I doubt she'd want to be living in the house she grew up in, especially if she can [-]get her own life[/-] find her own place. I wouldn't want to just hand her a house and rob her of her own sweat-equity experience!
The last 18 years have been a real testament to leverage & sweat equity. If loans weren't so cheap and credit so easy to get then we never would have become landlords. I have no desire to expand our empire, either, and personally I can cash out with no regrets. If we wanted to "save" something for our kid then I think TIPS or I bonds would do just as well as real estate, to say nothing of a small-cap value equity index or an international REIT.
Am I missing anything on the numbers, tax rates, or depreciation recapture?
I'm clueless on AMT-- is there anything here that would trigger it?