Obsessing over sell or hold decision

15 Replies

Hello all,

I have been worrying for a bit about our rental property and what to do with it. Should we sell it before we have to worry about capital gains? Should we keep it because of the positive cash flow and great tenant? There are a lot of variables here, at least in my mind:

We bought the home here in Utah in 2005. Refinanced in 2011 to get rid of the mortgage insurance. Moved out of Utah in 2012 and converted home into a rental property. Tenant moved in in June 2012. We returned to Utah and bought 2nd home in 2013.

Description of rental property: 4/2 2300 sq. ft., built in late 1970's. Some improvements made over the years. Generally in good condition. Important for Utah - next to elementary, one block from jr. high, 2.5 blocks from high school, 10 minutes from University.

Rent is $1000/month, 7% of which ($70) goes to property management company. (Remember, we had moved out of the state and didn't plan on coming back so soon).

Our mortgage + insurance + taxes on the rental is $644/month. From my rough understanding of the market, I believe we would be able to pocket anywhere from $25K - $40K if we were to sell at this time.

Our current financial situation is ok, but could become tight. A few of the main concerns: 1. Wife is pregnant, 2. Car seems to be close to giving up the ghost, 3. other debt payments. Selling the home would allow us to be in good shape financially and take care of the 3 issues listed above. Probably wouldn't be able to invest in another property, but could save the money for our own next home or use some to improve the home we are in.

The tenant's contract is up in June of this year. The tenant has indicated she would like to stay in the home following the contract's expiration in June. Tenant has recently requested we redo the driveway (which is admittedly in poor shape, especially for shoveling snow in the winter). The tenant has been a dream tenant - has kept the house in great shape, lives there alone w/no pets. Prior to contract being up last year, however, tenant requested a 6-month renewal, which we denied and tenant re-upped for 12 months.

By my understanding, and please correct me if I'm wrong, we still have about 15 months to sell the home without having to worry about a capital gains tax. If we have not sold the home before those 15 months pass, it is my understanding that a capital gains tax would be a pretty substantial hit on our equity.

So here are some questions I have for y'all:

Should we sell or hold???

Would this property be attractive to another investor assuming the tenant would stay?

Should I even take into account whether the tenant wishes to stay or not? (that was another reason I went with a property management company)

Please let me know if any other info. about this situation would be useful. Thanks for your help.

Sounds like you're an accidental landlord with some bad (any debt not adding to your net worth) debt. I'd sell and pay off as much debt as I could. The cap gains issue further solidifies my opinion.

However, if you are still on the fence try to decide it this way, as Dave Ramsey puts it, would you buy this house now?

I'd sell. Seems like one big issue with the rental could put you in a real bind. But having that extra cash to take care of those three items you mentioned would be a huge weight off of you and set you up better for future success.

I don't mean to hijack this thread but could someone explain the capital gains tax part? I thought you are only taxed on capital gains when the house is sold. Why would you be taxed for holding on to the property? Does it have something to do with the refinancing? Or maybe I'm reading incorrectly.

Sorry for the stupid question.

The way I understand it, the Capital Gains part is like this:

If you sell a rental unit, you have to pay capital gains tax. However, if the rental unit you are selling was your own primary residence during 2 years of the previous 5 total years, you do not have to pay that capital gain tax upon selling. In my case, over the past 5 years, the house in question was our primary residence for 3 years and 3 months, meaning we still have 1 year and 3 months (or 15 months) to sell the thing and not have to pay capital gains upon selling.

You are correct, there is no capital gains tax until a house is sold.

@Lee Busby

I might know of some people (as well as myself) that would be interested in your property. Do you have an address?

@Lee Busby Ah, that makes sense. I wasn't aware of that stipulation. Thanks for the help!

I'm not going to pretend like I have any experience with real estate investment. However, I'd like to think I'm pretty good with managing money. For whatever it's worth, I think selling the property would be beneficial to you. It seems like it could help you gain a little more financial flexibility and possibly help relieve some stress. Not to mention, you have one less thing to worry about while you and your wife have a child (congratulations by the way!).

Although, I'm just a college student trying to learn about real estate investment and have no experience with renting/selling properties or raising kids. So take this with a HUGE grain of salt. Good luck to you and your wife!

Originally posted by @Lee Busby :
The way I understand it, the Capital Gains part is like this:

If you sell a rental unit, you have to pay capital gains tax. However, if the rental unit you are selling was your own primary residence during 2 years of the previous 5 total years, you do not have to pay that capital gain tax upon selling. In my case, over the past 5 years, the house in question was our primary residence for 3 years and 3 months, meaning we still have 1 year and 3 months (or 15 months) to sell the thing and not have to pay capital gains upon selling.

You are correct, there is no capital gains tax until a house is sold.

That is incorrect. They changed the law in 2008. I believe the law reads that the five years and two years still apply, but you have to pay capital gains on the period you rented out the house for example if you rented it 40% of the time then your exclusion would be reduced by 40%. . Do some research on that.

Originally posted by @Cal C. :
Originally posted by @Lee Busby:
The way I understand it, the Capital Gains part is like this:
If you sell a rental unit, you have to pay capital gains tax. However, if the rental unit you are selling was your own primary residence during 2 years of the previous 5 total years, you do not have to pay that capital gain tax upon selling. In my case, over the past 5 years, the house in question was our primary residence for 3 years and 3 months, meaning we still have 1 year and 3 months (or 15 months) to sell the thing and not have to pay capital gains upon selling.

You are correct, there is no capital gains tax until a house is sold.

That is incorrect. They changed the law in 2008. I believe the law reads that the five years and two years still apply, but you have to pay capital gains on the period you rented out the house for example if you rented it 40% of the time then your exclusion would be reduced by 40%. . Do some research on that.

I think the 2 and 5 rule still applies. I'm not sure about the law changes, but I believe this IRS publication still applies: http://www.irs.gov/publications/p523/ar02.html

(see "excluding the gains")

http://www.irs.gov/pub/irs-pdf/p523.pdf

Check out page 16.

Hello @Lee Busby

If I understand the math correctly, you are putting $286 per month into your pocket after all expenses including property management?

My first piece of advice is have a real estate agent do a comparative market analysis (CMA) for you....and maybe even do up a seller's net sheet. Many agents offer to do the CMA for free and should show you the net sheet as part of their listing presentation. You need to know what you will most likely net after the sale closes (don't forget agent commissions and escrow fees). You say $25k to $40k.....that is a huge spread.....nail down the number so you can make a more educated decision.

Secondly, if you truly will net closer to the $40k, I say sell. My advice to you is to always have your own financial house in order first. Make sure you have 6 to 8 months worth of expenses saved in emergency fund in place in case of family emergencies. Make sure your Roth IRAs are being maxed out each year. If your company offers a 401k match then make sure you are contributing at least up to the match. Make sure you have enough life insurance on both you and your spouse. Cover yourself first and if you do, you will be financially sound and better able to do investments!

Originally posted by @Cal C. :
http://www.irs.gov/pub/irs-pdf/p523.pdf

Check out page 16.

Ok, that was quite useful. I tried to run some numbers and it looks like even if I would owe capital gains, it would only be on a very small amount. Here's a new wrinkle for you...It appears that my married filing jointly taxable income is less than $72,800, meaning we may qualify for the zero percent capital gains tax rate. Maybe I am getting all worried about capital gains tax when I don't even qualify to pay them in the first place.

Do you (or anybody out there) have any understanding about that?


@Lee Busby

After talking with a CPA, you lived in it for at least two years so that is good. You moved away in 2012 so you have three years from that time to sell without the 15% capital gains tax. But you do have to recapture the depreciation you have taken each year so you will just be taxed on that portion. The exact dollar amount will depend on how much depreciation you took and your CPA will need to plug those numbers in and give you that final tax dollar amount.

So if you decide to sell, you need to sell before summer of 2015 to escape the 15% capital gains tax! As far as how the "taxable income amounts" apply, definitely consult a CPA to get the nitty gritties. If you don't have one, I would be happy to give you the name and number of mine.

Also, if you're in SLC now, this might be interesting:

https://mjare.com/event-registration/?regevent_action=register&event_id=93

Matt's pretty accomplished and full of useful information.

Great question, this is one of the best problems to have. I faced a similar dilemma this week, where several months ago I decided to start a refinance and also put the property on the mls. I thought I would have a race and let fate decide if I should hold or sell. Would you believe that on the day the closing papers were being sent to me, I received an offer. I literally had closing papers for my refinance in one hand and the offer papers in the other. So fate, being the cruel mistress that she is, punted my indecision right back at me. It really is a good problem to have.

One of the things you did not mention was any vacancy/repair costs. Without going into details or trying to start another discussion, I would use 10% of the rental income, as a minimum. This brings your income down to about $180 per month (this is in line with what many landlords are getting). The other thing you did not list was the amount of cash you have on hand. I recommend a cushion of at least $5k if you are going to own rental property (I learned that the hard way when the roof mounted central heating went out and the subsequent crane rental and a new heater took a serious bite out of my budget.) If you have some cash to serve as a reserve, then you can consider retaining the property as a rental, if not sell, and start smaller.

Here is what I did. First I sat down and looked very closely at the rental income and expenses from this property. My property was doing pretty well (netting about $180 per door per month) although not in a fast appreciating area the rents have held reasonably steady. I then compared the rental income to the amount I would receive from the sale using after closing costs, capital gains, and commissions. I found out that I would clear about 3-4 years net rental income with the sale. The refinance would allow me to pull all of the cash out that I had into the property. One other thing you didn't mention was how much cash you had into the property. There are almost as many ways to look at an investment as there are investors, but I usually like to look at cash on cash return. I will define that as = net annual cash flow/cash out of pocket. Since I have no cash into the properties, my return was undefinable, so this isn't the best way to look at this one. Finally I compared what I would do with the cash versus what I would loose in the rental income, and decided that the rental income was a better return than I would likely get with the cash. Your circumstance will help you answer that question.

Good luck and congratulations. I hope lots of these types of problems in your future.

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