Rental property- sell? any way to take cash out?

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togb
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Rental property- sell? any way to take cash out?

Post by togb »

I own a rent house (no mortgage) that cash flows nicely. It's just 5 years old, in nice condition. At some point I'll need to replace the privacy fence around the back yard, and eventually a hail storm will mean the roof needs replaced but routine maintenance has been minimal.

I want to free up some cash to do some improvements on my main residence. I don't want to take money out of retirement funds- before tax creates an unwelcome taxable impact, and I'm trying to build/preserve roth funds.

Real estate prices are really strong right now, which leads me to consider selling the rent house. (Basis is 175K, current value probably 300K) I've had good tenants, but always dread finding new tenants.

If I sell, I'll incur capital gains and recapture of depreciation as ordinary income. I estimate the tax bite at $55K, so profit is maybe $60K after selling costs and taxes. But cash in hand is more than $200K. I'll lose the monthly rent check. I'll also get out of managing the property before I have experienced any of the potential awful stuff that can happen.

I did some research and it seems I can't get out of the taxes, even if I were to live in the house for 2 years. And I'm not sure it makes sense to roll proceeds into another rental, since I don't want to manage a property long term.

Am I missing anything that is smarter than selling? I'm assuming I can't do a cash out finance, since I already own it. I don't want to finance unless the interest is deductible to offset the rental income. Should I just be happy to sell and have money in my pocket after the taxes?
WildBill
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Re: Rental property- sell? any way to take cash out?

Post by WildBill »

Howdy

Take a mortgage out on it. The interest is a business expense you deduct from rental income in your rental p&l when you do the numbers for taxes.
"Through chances various, through all vicissitudes, we make our way." Virgil, The Aeneid
BlueCable
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Re: Rental property- sell? any way to take cash out?

Post by BlueCable »

togb wrote: Sun Nov 28, 2021 10:26 am I don't want to finance unless the interest is deductible to offset the rental income. Should I just be happy to sell and have money in my pocket after the taxes?
Why are you against taking out a mortgage? If it is a profitable investment with 100% equity, then it should be even more profitable when leveraged.

Of course, if you just don't want to be a landlord, then sell it. Nothing wrong with avoiding future headaches.
Last edited by BlueCable on Sun Nov 28, 2021 10:35 am, edited 1 time in total.
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Sandtrap
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Re: Rental property- sell? any way to take cash out?

Post by Sandtrap »

togb wrote: Sun Nov 28, 2021 10:26 am I own a rent house (no mortgage) that cash flows nicely. It's just 5 years old, in nice condition. At some point I'll need to replace the privacy fence around the back yard, and eventually a hail storm will mean the roof needs replaced but routine maintenance has been minimal.

I want to free up some cash to do some improvements on my main residence. I don't want to take money out of retirement funds- before tax creates an unwelcome taxable impact, and I'm trying to build/preserve roth funds.

Real estate prices are really strong right now, which leads me to consider selling the rent house. (Basis is 175K, current value probably 300K) I've had good tenants, but always dread finding new tenants.

If I sell, I'll incur capital gains and recapture of depreciation as ordinary income. I estimate the tax bite at $55K, so profit is maybe $60K after selling costs and taxes. But cash in hand is more than $200K. I'll lose the monthly rent check. I'll also get out of managing the property before I have experienced any of the potential awful stuff that can happen.

I did some research and it seems I can't get out of the taxes, even if I were to live in the house for 2 years. And I'm not sure it makes sense to roll proceeds into another rental, since I don't want to manage a property long term.

Am I missing anything that is smarter than selling? I'm assuming I can't do a cash out finance, since I already own it. I don't want to finance unless the interest is deductible to offset the rental income. Should I just be happy to sell and have money in my pocket after the taxes?
There are least 5 big reasons to sell as quoted above.
And, one big reason to be happy to walk away from your rental with money in your pocket.

The decision is only "yours" and what fits for how you feel now, how "your" numbers work for you now, and how "your" plans are going forward.

Based only on what you present and not what I would do. . . Sell.
j :D
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AnnetteLouisan
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Re: Rental property- sell? any way to take cash out?

Post by AnnetteLouisan »

RE family here. You know the expression about the “haves” and the “have nots?” Well when it comes to RE selling we think of the “have tos” and the “don’t have tos.”

You are in a great spot because you don’t have to sell. You can sell at a time that makes sense for you, if you decide, judging the market and all factors but you are under no pressure to decide.

If you want to make improvements you have a variety of options, including a heloc or saving a few rent checks. If you want to sell now, fine.

If you haven’t had problems with your rental (only 5 years old and in good condition), any problems others may have had (which I articulated elsewhere at length relating to much, much older houses and buildings in high density, tenant friendly locations btw) are kind of irrelevant. It’s true it’s a seller’s market now but it could last. When you sell obviously you give up the rent check, control and all future possible appreciation. Is that worth the $60k profit, when you have 200k?

Just take your time and wait until you are sure.
Last edited by AnnetteLouisan on Sun Nov 28, 2021 12:33 pm, edited 2 times in total.
IMO
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Re: Rental property- sell? any way to take cash out?

Post by IMO »

WildBill wrote: Sun Nov 28, 2021 10:29 am Howdy

Take a mortgage out on it. The interest is a business expense you deduct from rental income in your rental p&l when you do the numbers for taxes.
From my understanding, you cannot just re-mortgage your rental property to take cash out and then just use that cash for whatever one chooses while at the same time now claiming that as one of your rental expenses. It also gets more complicated because even if one used that cash out money to do capital improvements to the rental property, that would have to be depreciated over the proper depreciation schedule.

I think that any cash out money would have to be invested into another investment (be it real estate or otherwise), and then require tracking of the money to the new investment and it's expenses/income. I believe this is how some that invest in property are able to leverage equity in a rental forward to a new property.

I have rental properties, and it would be nice to just take out equity on a cash out to do whatever I wanted with it, and then deduct the interest on the rental income.

I'd tread carefully here at consult a tax professional to be sure I wasn't doing something not allowed by the current tax codes. Don't confuse doing something that isn't legal and not getting audited as evidence that makes something legal.

The other drawback is mortgage rates on investment properties are not as favorable as primary/secondary home mortgages.
RedDog
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Re: Rental property- sell? any way to take cash out?

Post by RedDog »

Although not your central point, it’s worth bearing in mind that hail damaged roof replacement cost are typically covered by insurance. Of the three rental home roofs that I’ve replaced in the last13-years, two have been covered and one paid for out of pocket.
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togb
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Re: Rental property- sell? any way to take cash out?

Post by togb »

thanks for lots of good perspective. I did some checking-- and I can't simply finance it now that I've paid it off, and then deduct interest again. Even if I just financed for the amount I paid off, that's not how it works. The only way to get it done would be to create some sort of entity, and sell it to the entity and have it financed by that trust/LLC/business/whatever and that's way too complicated. Rates were not very attractive on the initial quotes anyway.

Great point that I'm lucky to be in a place where I could sell for a profit, but don't have to sell. I penciled out keeping and and selling it. For the near term, I'm really just as smart to keep renting it and using the cashflow to make life better. If I need a roof, it's insured. If I have to do anything else, I've got reserves set aside for that purpose. After my taxes, insurance and reserves, I still clear almost $1000/month and that's what I continue to do. I'm going to favor that cashflow over locking in a profit.

Really appreciate having this forum as a smart, unbiased sounding board. It was a lucky day when I found this forum.
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AnnetteLouisan
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Re: Rental property- sell? any way to take cash out?

Post by AnnetteLouisan »

Good job! Good decision. My guess is it will keep appreciating and you can always sell later if you decide to.
michaelsieg
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Re: Rental property- sell? any way to take cash out?

Post by michaelsieg »

I am sorry to disagree, but I have taken out mortgages on investment properties that are fully paid off. This is a very common practice and you don't need to sell the property to another entity (that you own as well)- mortgage rates for residential investment properties are not quite as low (or I can't find any that are as low) as home owner's mortgages. I am currently refinancing a property and I am getting a rate of 3.5% on a ARM. So all I am saying is that a cash out refinance is an option and many real estate investors use this to grow their portfolio. The mortgage interest of your refi is fully deductible from your rental income.
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togb
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Re: Rental property- sell? any way to take cash out?

Post by togb »

michaelsieg wrote: Tue Nov 30, 2021 9:31 pm I am sorry to disagree, but I have taken out mortgages on investment properties that are fully paid off. This is a very common practice and you don't need to sell the property to another entity (that you own as well)- mortgage rates for residential investment properties are not quite as low (or I can't find any that are as low) as home owner's mortgages. I am currently refinancing a property and I am getting a rate of 3.5% on a ARM. So all I am saying is that a cash out refinance is an option and many real estate investors use this to grow their portfolio. The mortgage interest of your refi is fully deductible from your rental income.
Really? Can you deduct the interest again or do you just hold the mortgage personally?
IMO
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Re: Rental property- sell? any way to take cash out?

Post by IMO »

michaelsieg wrote: Tue Nov 30, 2021 9:31 pm I am sorry to disagree, but I have taken out mortgages on investment properties that are fully paid off. This is a very common practice and you don't need to sell the property to another entity (that you own as well)- mortgage rates for residential investment properties are not quite as low (or I can't find any that are as low) as home owner's mortgages. I am currently refinancing a property and I am getting a rate of 3.5% on a ARM. So all I am saying is that a cash out refinance is an option and many real estate investors use this to grow their portfolio. The mortgage interest of your refi is fully deductible from your rental income.
I think your post is somewhat right and somewhat wrong. I'll try to explain why I believe that:

1st, the why I think part of your post is wrong:

If we take a scenario, you have a rental property with worth $500k, and it has a mortgage of $100K left on it. As such, if one decides to do a cash out refinance and take out a new mortgage for $400k. On the surface on the new mortgage, it sounds like your good, you have the rental securing the new mortgage with the now higher interest expense. So I then decide, why not take that $300k of cash I now have and pay off my personal residence mortgage (that happens to lets say have a $300k mortgage left on it). I decided this because the tax law changes no longer favored me itemizing/deducting my personal mortgage interest on my income taxes because I lost the SALT deductions. It all works out, I was now able to take my non-deductible personal mortgage and essentially I have put it on my rental property. And since rental properties allow you to deduct mortgage interest, it's all a win for me. When I do my taxes for the next year, I simply change the amount of interest on my schedule E on the rental property for mortgage interest. The IRS doesn't question it, there is not IRS audit letter, and thus it MUST be a legitimate thing I did with the cash out refinance.

But I do not think that is legitimate. Again, because that doesn't get audited at the current time doesn't make it legitimate. If a future tax return gets audited and it turns out I actually wasn't allowed to do that, then I would suspect I'm on the hook for back taxes and probably fines/past interest etc.

2nd, the why I think part of your post is right:
Same scenario on the rental property and cash out refinance giving your $300k cash. In this case, if I allocate $100K of mortgage (and it's interest) to my rental property, I can continue to deduct the portion of interest for that $100K on my schedule E. It takes more work, I have to break the mortgage/interest out percentage-wise, but since I acquired $100K of debt(with it's interest) that is secured by the rental property, I can continue to deduct that portion of the $100K worth of mortgage against my rental income.

But in this 2nd scenario, I decide, I want to expand my rental empire and leverage that extra $300K and buy another investment property. For a twist, we'll say it's in a different state, one with high income taxes. I do this and I end up with a new rental property (lets say for simplicity it costs me exactly $300K). I would now be able to deduct any mortgage interest against rental income on the new home. So in this case, I allocate the $300K of that original cash out refinance AND it's interest to the new rental property. Thus I essentially am deducting the full $400k mortgage from that original cash-out refinance.

I think this IS legitimate based on current tax laws. I think this is where you are correct on your post.

I did throw in the twist of giving an example where you bought the 2nd rental property out of state with a higher income tax. Reason being is that it gives the example of why one would allocate that portion of the cash out mortgage to this new rental property. Not only do I believe that the IRS would require you to properly allocate investment interest to the proper investment income, but in my example it shows that you would want to because the state of the 2nd rental property actually has higher income taxes and you'd want to deduct your rental income from this new property from it's rental income.

----

Now, I'm not a tax professional. I just try to read as much as I can on these topics (I do have rental properties). I'll try to update this post with some references that support what I'm claiming. I do think it's also legitimate to do that cash out refinance and use the proceeds to make other investments that are not another rental property. Just think the money/expenses have to be properly tracked to the particular investment. My 1st post infers that.

Ultimately though, I think op should contact a tax professional to make sure anything done is legitimate and done correctly. I'll reemphasize, many people can and do things that are not legally legitimate regarding taxes all the time and get away without being audited. That doesn't mean what they did is legitimate.

EDIT: He's a quick link (and I cut/pasted a section of it below) from NOLO: https://www.nolo.com/legal-encyclopedia ... perty.html

"Loans on Rental Property Used for Nonrental Purposes
You can take out a loan secured by your rental property and use the proceeds for nonrental purposes. If you do this, you can't deduct interest you pay on the loan as a rental expense. Whether it is deductible at all, and to what extent, depends on what you use the money for:

Personal purposes. You get no deduction if you use the loan proceeds to buy something for your personal use—for example, you take a vacation or buy new appliances for your residence. Personal interest is not deductible, except for interest paid certain home mortgage interest and interest on student loans.
Investment purposes. You may get a deduction if you use the loan for investment purposes—for example, to purchase stocks or bonds or some other investment. You can deduct investment interest as an itemized personal. However, you can deduct investment interest only from investment income. Thus, if you have no investment income, you get no deduction. If your interest expense exceeds your investment income, you cannot deduct the overage. You must carry it forward to deduct in a future year when you have enough investment income.
Business purposes. You can deduct the interest if you use the loan proceeds for a business other than renting residential property—for example, a landlord borrows money on his rental property to purchase equipment for his construction business. You can fully deduct business interest as a business expense in the year in which it is paid."
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