Seeking advice with rental loss

[Elizabeth Weber]

Hello! I am in need of advice - I have a single family long term rental in a new construction community in Queen Creek, Arizona, purchased in 2023. I have a high interest rate (7.2%) and am all in at $475k, with $425K left on loan. Homes are still being sold by the builder in the community with incentive packages, and the area is over saturated with new builds for sale and for rent. Prices are stagnant or have slightly decreased since 2023. My tenant has been there for apprx 1.5 years and is paying above market rent (she pays $2750 a month). However, I'm still at about a $900 monthly loss. She just renewed another 12 month lease at same price (she's already paying slightly over market average).  I would like to cut my losses and get out and sell. However, the market is over saturated, and homes are sitting for months on end (up to 9 months) and prices are stagnant- so I have essentially no equity. If I sell, I am expecting to break even or take a slight loss. 

She is interested in buying the property, but she will not be approved by traditional lenders as she's self employed with lower credit and needs two more years of tax returns and to increase income. Here's where I'm unsure how to proceed- as I believe I have 3 options: 

- Offer a rent to own structure to her- with a nonrefundable option fee, and she takes on the full monthly payment, but must refinance me out within 12 months (this stops my bleed most immediately) 

- List home off market with tenant in place (still has 12 months on lease) - see if an investor would purchase (however, I'm not sure I could sell to an investor without having to bring cash to close, which I want to avoid)

-List home traditionally and work with her to offer incentive for cooperating with showings, etc should home sell (it may sit for months, I'm still losing $900 a month while it sits, to hopefully sell traditionally and break even or worse)

I recognize this is not a good place to be, so hoping for some constructive advice of solutions of how to best proceed in a way that acknowledges the reality of the situation, and stops my bleed. Thank you in advance! 

[Jason Malabute]

From a tax perspective, one thing to consider is that if you sell the property at an overall loss after taking into account your purchase price, improvements, closing costs, and prior depreciation, that loss may qualify as a Section 1231 loss. A Section 1231 loss on a rental property is generally fully deductible against ordinary income, such as W-2 income or business income, which can make the economic impact of taking a loss somewhat less painful.

Also, if the property is sold at an overall taxable loss, there generally is no depreciation recapture. Depreciation recapture only applies when you sell for more than the property’s depreciated tax basis. So if you are truly selling at a deductible loss, you would typically get the benefit of the loss deduction without having to pay tax on prior depreciation.