Rental Sell or Keep Decision help

Non-investing personal finance issues including insurance, credit, real estate, taxes, employment and legal issues such as trusts and wills
Post Reply
Topic Author
uwbadgers
Posts: 86
Joined: Mon Aug 25, 2014 3:36 pm

Rental Sell or Keep Decision help

Post by uwbadgers »

Hi,

Looking for some thoughts/feedback/advice on our rental property situation. It's not a "problem" at all but more so trying to determine which decision may be most beneficial long term. I have asked some questions on this before but a few things have changed since then (we moved to a new house, mortgage is now 0 on the rental)


2007 purchase----190k (a condo)

Estimated sale 2018---220k (same unit just sold for this a few weeks ago)

Mortgage: Paid off in full

Rented for last 5 years, same people.

This was an "accident" as we did rental so we could buy a new house back then. Condo didn't have enough owners/renters as it was a conversion so traditional loans were hard. That time has long passed and selling + people getting loans for it is fine.

New management company recently and they are "pushing" renting out a bit. Need to do a $250 application fee now and get more approval. We had to get approval previously, but no fee. Not really a big deal and nothing that will stop us, but just something that's new. There are very few rentals in the condo complex of ~90 units.

We've lucked out as we've had literally 0 issues these 5 years besides a few, small special assessments, but nothing strange. Maintenance needs happen.

The renters want to renew again but really we are trying to decide when, if, and how we know when to sell. It's not a hassle by any means, but we're trying to decide if we could take that profit and do "better" things.

Stats below:

Currently
Rent: $1450/month
Expenses $650/month (taxes, misc, prop manager, HOA)

Net Profit: $800/month


If Sold:

Sale: 220k
Mortgage: 0

I don't fully understand the tax implications of the sale, any thoughts here? I would assume since the "gain" is only ~30k the tax hit is low? We claim depreciation and paid 190k back in 2007 (it dropped a lot and is now recovered some value).

Our HHI is ~175k/year (not including rental income ~10k/year)
Retirement Accounts: ~325k
Ages: 33 and 33, 2 kids
0 debt besides current mortgage (440k, House ~700k)


If sold what would we do with money?

Assuming ~175k after taxes + realtors

25k: Fun Money :) Vacation savings and things like that (kids are 4 and 2, maybe Disney soon)

50k: Fill up savings account more (both have slightly variable income job so having extra is good (one month may be 30k, next month 5k)

100k: 529 for kids? We currently have saved 20k for them, not in 529 right now.

I guess we aren't totally sure what we'd actually do with it and if it's more beneficial to keep holding and taking that income. We both aren't really sure how to analyze the situation.

Happy to hear any thoughts or feedback from looking at these numbers.
JBTX
Posts: 8054
Joined: Wed Jul 26, 2017 12:46 pm

Re: Rental Sell or Keep Decision help

Post by JBTX »

uwbadgers wrote: Thu Feb 08, 2018 12:15 pm Hi,

Looking for some thoughts/feedback/advice on our rental property situation. It's not a "problem" at all but more so trying to determine which decision may be most beneficial long term.


2007 purchase----190k (a condo)

Estimated sale 2018---220k (same unit just sold for this a few weeks ago)

Mortgage: Paid off in full

Rented for last 5 years, same people.

This was an "accident" as we did rental so we could buy a new house back then. Condo didn't have enough owners/renters as it was a conversion so traditional loans were hard. That time has long passed and selling + people getting loans for it is fine.

New management company recently and they are "pushing" renting out a bit. Need to do a $250 application fee now and get more approval. We had to get approval previously, but no fee. Not really a big deal and nothing that will stop us, but just something that's new. There are very few rentals in the condo complex of ~90 units.

We've lucked out as we've had literally 0 issues these 5 years besides a few, small special assessments, but nothing strange. Maintenance needs happen.

The renters want to renew again but really we are trying to decide when, if, and how we know when to sell. It's not a hassle by any means, but we're trying to decide if we could take that profit and do "better" things.

Stats below:

Currently
Rent: $1450/month
Expenses $650/month (taxes, misc, prop manager, HOA)

Net Profit: $800/month


If Sold:

Sale: 220k
Mortgage: 0

I don't fully understand the tax implications of the sale, any thoughts here? I would assume since the "gain" is only ~30k the tax hit is low? We claim depreciation and paid 190k back in 2007 (it dropped a lot and is now recovered some value).

Our HHI is ~175k/year.
Retirement Accounts: ~325k
Ages: 33 and 33, 2 kids
0 debt besides current mortgage


If sold what would we do with money?

Assuming ~175k after taxes + realtors

25k: Fun Money :) Vacation savings and things like that (kids are 4 and 2, maybe Disney soon)

50k: Fill up savings account more (both have slightly variable income job so having extra is good (one month may be 30k, next month 5k)

100k: 529 for kids? We currently have saved 20k for them, not in 529 right now.

I guess we aren't totally sure what we'd actually do with it and if it's more beneficial to keep holding and taking that income. We both aren't really sure how to analyze the situation.

Happy to hear any thoughts or feedback from looking at these numbers.
I don't have any experience in property investments....that said

$9600 /approx $200k is just under 5% return. That isn't bad given low returns across most asset classes, but isn't great given theoretical risks involved with rentals. Maybe somebody here can give you better idea of how that stacks up.

Your tax basis for determining taxable gain would include any depreciation that you may have taken on the rental, so your gain will likely be larger than $30k.

As to what to do with it, make sure you have maxed all potential retirement accounts - you are in really good shape for your age.

$100k is a lot to put into a 529, plus there are contribution limits per year (or over 5 years). You could theoretically make a one time payment of $50K into each, and not contribute again until 5 years ago.

You can't know for sure your kids will go to college, and $100k could be $200k to $300k in 16 years. That is a lot for college. I would probably fund it more modestly, and put balance in a taxable investment account.

Also perhaps consider buying some ibonds for your savings account allocation - you can buy $20k per year for a couple.

As to fun money, you certainly are in good shape, and you can afford that amount, but if it were me I'd probably designate maybe $10k and put the rest in a liquid reserve.
riverguy
Posts: 505
Joined: Sun May 23, 2010 10:33 pm

Re: Rental Sell or Keep Decision help

Post by riverguy »

5% return sucks for a rental. I would sell it.
User avatar
Pajamas
Posts: 6015
Joined: Sun Jun 03, 2012 6:32 pm

Re: Rental Sell or Keep Decision help

Post by Pajamas »

riverguy wrote: Thu Feb 08, 2018 1:40 pm 5% return sucks for a rental. I would sell it.
That's pretty much what I was thinking, too. Sounds like after transaction costs and taxes you won't haven't really made anything close to 5% a year on it, though.

You could invest the returns according to your asset allocation, spend it, a combination of those, something else.
psteinx
Posts: 3599
Joined: Tue Mar 13, 2007 2:24 pm

Re: Rental Sell or Keep Decision help

Post by psteinx »

Quick analysis:

Value: 220K

But, what you'd really realize, after fees, commissions, repairs, etc, is probably closer to 200K. You've been conservative and said 175K, but I think that may be too conservative.

Net Income: ~$9600/year

Is it fair to assume that your cost estimates (and thus net income estimates) reflect reasonable estimates for less common, but potentially pricey stuff? Condo assessments, major repairs, etc? I'll assume so, in this analysis, but think about that...

OK, so, 9600/200000 = 4.8% cash return

In addition, there's a less visible return - appreciation (or depreciation).

That's harder to estimate. You haven't had great appreciation, to date, but it hasn't been zero either. You'll have to think about what this might be in the future. Depends on the attractiveness/growth of the area, appeal of the condo complex itself, and so on... A reasonable ballpark for a "medium" growth, medium quality area and condo complex might be inflation - i.e. price/value grows roughly in line with inflation. In which case, your 4.8% return is approximately a "real" return...

Note that this is a pre-tax return, and given your income, probably gets whittled away at heavily by taxes, although depreciation deductions may help some. Then again, many possible alternative investments (if you sold) would also be taxable (albeit perhaps at lower rates). 529s are tax favored though, fwiw...

Next up - management headache. Many folks don't like owning physical property because of the management headache. But you're in pretty good shape on this count. You've had the same tenants for 5 years, and they want to stay longer. You've got a management company. It sounds like this is a low hassle investment for you.

So, you could sell it, and put the proceeds (less taxes) into other investments. My guess is that, to a first approximation, other investments would be in the same broad ballpark, return-wise, as this condo. Taxes and such would play a role.

If it were me, given that you've got long term tenants who want to stay, and that you face no real pressure for extra cash, nor deadlines for tax-related changes, I'd probably hold onto it for the time being, until something changes. When the current tenants want to leave might be a good point to get it cleaned up some, painted, and put it on the market...

EDIT: Of course - do your own analysis. The tax issues in particular are somewhat complex. There are no guarantees of positive returns for this condo nor for many of the alternatives you might consider with the proceeds...
Topic Author
uwbadgers
Posts: 86
Joined: Mon Aug 25, 2014 3:36 pm

Re: Rental Sell or Keep Decision help

Post by uwbadgers »

Hi all,

Thanks for the feedback so far. To answer/follow up on a few things.

1. Yes, the property has just started to appreciate a bit, but it took ~10 years to get back to what it was purchased for in 2007....poor timing :) I would think the area continues to go up as it's in a nice part of town, good schools, etc. The complex itself is ~15 years old but kept up in good condition.

2. As far as expenses, I included everything in my calculation, including special assessments. We've had a few over the 5 years usually ~600-800$ each time, but all of that included with other expenses average out to only ~$40/month over the last 5 years.

3. The "cash" invested into this when my wife purchased it was an ~80k gift downpayment. Over the course of owning/renting along with some of our own payments we took the mortgage to 0.


From what a few of you wrote, if we sold at 220k and 190k was the cost, we have 30k that is taxed as "capital gains," correct?

Plus, any depreciation claimed adds on to this "Gain?"

Then, ONLY that amount is the taxed amount?

The ~180-190k "leftover" is not taxed since it's not a "gain?" OR am I totally missing how that works?
psteinx
Posts: 3599
Joined: Tue Mar 13, 2007 2:24 pm

Re: Rental Sell or Keep Decision help

Post by psteinx »

You will have a basis in the condo.

Determining what that basis actually is is a bit tricky. I can't remember the details - you'll probably want to research on your own. I'm not sure if the starting point is what you paid, or what its value was at the time you converted from personal use to rental.

Then, that original basis will be modified. Depreciation will reduce the basis (and thus likely increase your taxable gain when you sell). But the depreciation part is, I think, handled somewhat separately, and generally taxed more than ordinary gain (i.e. at a higher rate). So if it the original basis was 190K, but you've had 20K in depreciation, and you sell for a net of 200K, you might have 10K that was taxed as conventional capital gain, and another 20K taxed as depreciation recapture, at a somewhat higher rate.

My understanding is that you owe taxes on the depreciation you should have taken (per IRS guidelines), *EVEN IF YOU DIDN'T TAKE IT*. This trips some folks up.

Next, your basis may move UP (thus lowering your taxable gain), if you've made capital improvements to the property. There's a difference between such improvements and ordinary maintenance. Also, not sure how condo assessments may play into it. i.e. Perhaps there is a difference if the condo association did a special assessment for a newly built garage, versus routine roof repair.

Also, determining proceeds from the sale - gross versus net, etc., likely involves some nuances...

More generally, a lot of this stuff is complex, and you should probably find the relevant IRS publication(s) and review them, and/or consult an accountant. But probably, you'll have a basis somewhere in the $150-190K range, and thus the bulk of your receipts, if you sell, will likely not be taxable...

Again, please do you own research. I am not a CPA nor a lawyer.
User avatar
Meg77
Posts: 2680
Joined: Fri May 22, 2009 1:09 pm
Location: Dallas, TX

Re: Rental Sell or Keep Decision help

Post by Meg77 »

Hey there, fellow landlord here. I would not sell this investment for a variety of reasons.

1. Your perfect long-term tenant wants to renew their lease.
2. You don't have any better ideas on what to do with the proceeds. Vacations, cash and 529s aren't compelling.
3. This is generating a steady 7% return (4.8% cash flow and 2.2% appreciation) with little to no effort on your part and precious little risk given that there is no rental mortgage and that there appears to be a functioning HOA board with strong regulations and few other rental units in the complex.
4. You are underestimating your capital gains taxes. If you've been depreciating this asset on your tax returns each year, then you'll have around $30k of capital gains plus depreciation recapture tax of 25% of whatever the total depreciation you've expensed over the lifetime of the asset.
5. Transaction costs are high to sell or buy real estate. Sure, a 7% annual return isn't amazingly wonderful, but do you really want to pay $13k - $15k in realtor commissions and title work just to offload this - plus $4500 in capital gains and probably $10k or so in depreciation recapture?

If I were in your shoes - and I actually am, with a condo that doesn't cash flow well but has had a steady tenant - I would at least wait until the tenant chooses not to renew the lease to consider selling. Or until you identify a more compelling investment opportunity. In the meantime, let it ride. It's called Buy and Hold Strategy - and it works!
Last edited by Meg77 on Thu Feb 08, 2018 3:48 pm, edited 1 time in total.
"An investment in knowledge pays the best interest." - Benjamin Franklin
Liberty1100
Posts: 256
Joined: Fri Nov 21, 2014 12:36 pm
Contact:

Re: Rental Sell or Keep Decision help

Post by Liberty1100 »

Have you increased the rent over the past 5 years? That could be why it is only a 5% ROI. It is very common to increase the rent every year 2-3%. If they have lived there for 5 years, they might not want to move over less than a $100/month increase.

It may be worth a talk to your property manager or real estate agent to see what the current rate is. It could be surprising and make a better outcome for you.
Topic Author
uwbadgers
Posts: 86
Joined: Mon Aug 25, 2014 3:36 pm

Re: Rental Sell or Keep Decision help

Post by uwbadgers »

" Transaction costs are high to sell or buy real estate. Sure, a 7% annual return isn't amazingly wonderful, but do you really want to pay $13k - $15k in realtor commissions and title work just to offload this - plus $4500 in capital gains and probably $10k or so in depreciation recapture? "

------>Well, not really :) It does help hearing it laid out that way. That's really been our struggle, trying to lay this out in an objective way to decide what may be the best route, while I know that is still coming down to personal preference.


"Have you increased the rent over the past 5 years? That could be why it is only a 5% ROI. It is very common to increase the rent every year 2-3%. If they have lived there for 5 years, they might not want to move over less than a $100/month increase. "

------>We started at $1400 back in 2013 and have been at $1450 since 2015. I think $1500 is a reasonable increase for this next cycle. Since the tenants have been so easy and problem free we didn't want to raise each year and possibly have them leave over $25/month.
Post Reply