Thinking hard about selling our one and only rental home.
Wife is sick and tired of dealing with renters tearing up the place and also dealing with property managers who take less than adequate care of the property. The house is too far away to personally manage.
Since we evicted the last set of deadbeats we have been doing some serious repairs (of their damages) and some equally serious upgrading in preparation for raising the rent to be more in line with the prevailing rents, which are quite substantial.
However, the more we talk with the people we know who are renting their properties, the more we think we should cut and run. My wife says I would have to put her away if the next renters tore up our work.
We were intending the rental income to be part of our retirement loot but by the time I’m out of debt (ha, ha) and able to utilize the income and not just turn it over into our current mortgage payment I won’t need much more than a rocker, bedpan and supplemental oxygen.
The current thought is to put it on the market and hold out for the asking price.
Then take the proceeds after costs and pay off our residence mortgage, my new van and the travel trailer. Finally, all the big debt GONE. I kind of like the idea of saving megabucks in interest payments.
The big question is minimizing the capital gains tax. So far, I know I can deduct the original cost of the house plus improvements and selling costs. I’ll be checking with a CPA (hello, anyone?) here and see if paying off my mortgage will be treated the same as rolling a sale into a new purchase. We’re also wondering if, since a self contained travel trailer is considered a second home and as such qualifies for the interest deduction on schedule A, paying off that mortgage would also qualify as a rollover of sales proceeds for capital gains reduction.
Once the rollover is completed to our personal residence the proceeds would seem to be protected from capital gains tax should we decide to sell that. I would think that if we could deduct the rollover to the travel trailer we would never have to pay the tax because the TT would not appreciate, in fact, would actually be valued less than the amount rolled in. Wishful thinking, maybe.
Then we could think about where to put the rest of the money. Maybe there are investment programs, such as IRA’s, that would allow further deductions for capitals gains tax reduction. We would prefer not to persue aggressive investment, I’ve already had one of those money losers.
Replies
Talk to your accountant about 1031 exchange
Note that the gains on rental property is different/separate from gains on a "primary residence". There may be ways to "roll over" the gains, but I'm pretty sure it would have to be into another income property, not for "primary residence".
The only ways I am aware of to avoid capital gains taxation on a rental property (read: investment property) is to do one of the following:
1. Sell your primary residence and move into the rental. Live there for two years, then sell. You are subject to the capital gains exclusion for each sale, which I believe is $500K in gains. Two years can go by quickly, especially if you are remodeling and fixing up the whole time. Run some numbers on this to see what it is worth.
Let's say you are looking at a gain of $400K, for which the fed will want 15 percent, and your state may want something, also. You could be looking at a tax bill of maybe $75K, all or most of which could be saved by moving in and living there for the two year minimum. It is like paying yourself, net, $37.5K per year.
2. Sell the rental and buy another investment property (or properties) with a total value equal to or greater than the sale price realized. The transactions are done under a 1031 exchange, for which you will need a qualified agent.
Beyond what Gene said, you also have depreciation recapture to pay at a rate of 25%. And the feds don't even care if you did not take the depreciation as a deduction you still must pay the recapture for what you should have taken.
In a 1031x you end up paying the tax on any profit you touch and you don't eliminate the tax on the rest you just push it into the future.
If you have an other business you could use a rapid depreciation on a piece of equipment to offset some or all of your gains, but then you are spending your money on something else.
I am currently in the same situation you are and have been looking in to my options. So it would be great if someone had a better option
A 1031 exchange has a number of specific requirements about what can be bought and when. You have to purchase "similar" investment property.
However, there is a wide latatuide on what is similar. For example you could buy a condo or commerical property for rental.
You *might* even by a piece of equipment that you rent to your business and others. Don't really know, but you might want to look into that.
And the 1031 just delays capital gains (and possibly the depreciation recaptions).
However, long term (over one year) capital gains is a maximum of 15%.
Be sure to check how your state treats capital gains. New York, for example, doesn't have a treatment for capital gains, taxing them instead as ordinary income.
Ouch!
Hey Ralph, everyone already told you your front line options are either live in it for two years or do a 1031 exchange.
Beyond that, get your accountant to go over your whole picture to look for opportunities.
I understand that you likely won't want to live in it if it's out of state.
Managing out of state property is a chore. One of the best bargains I picked up was a nice duplex that was owned by folks that moved away. Very tough to manage from a distance and they just wanted out.
1031 exchange is more of a tax deferral than a tax savings. If you don't want to stay in the real estate investment game long term, it may not do much for you.
If you have any stock that isn't doing well, might be the time to realize a loss on that to pair with the gain on the prop.
Last, for the depreciation recapture, it is true that you will have to depreciate your basis at whatever depreciation you could have taken, whether you did or not. Couple strategies there.
If you did take the depreciation, but couldn't use it all (loss carryforward) you get a depreciation recapture recapture. What you took (or could have taken) but could not use gets added back to the basis.
If you didn't take the depreciation and have to calculate it now, the depreciation is only on the building, not the land. There is some flexibility there.
Anyway, good luck and use a good accountant.
"Let's get crack-a-lackin" --- Adam Carolla
Ralph-
In case you aren't confused enough, a couple more thoughts.
If you didn't take the depreciation and need to, you can always go back for the last three years and file amended returns.
As far as the concept of using the funds from a sale to pay down the loans on either your home or the travel trailer, that likely isn't going to work. It's definitely unacceptable from the standpoint of a 1031 - since among other things, neither of those items appears to be business property. 1031 exchanges are great. I've done several. They can be done with different kinds of business property, but it needs to be "like kind". So, no swapping the three Porches for a beat up rental property - different types of property. Since you have real estate, you need to go with more new (to you) real estate. The trailer might be considered, but since you own it already, and it's a pleasure vehicle, that's not going to work.
Set up the appointment with the CPA now. Many of them take a week off after 4/15, so you might find one in the office soon.
Don K.
EJG Homes Renovations - New Construction - Rentals