Would you rent or sell this property?

Question

I have an investment property in Santa Rosa, CA that I bought in 2009. Loan on the property is for 112k, comps support that it's worth 355k. I did live in it, but it's been a rental for over 3 years and I'm outside the primary residence window. My yearly income is zero because of deprecation and I don't have income outside the property, but the capital gains are going to throw me into the higher tax bracket. It's possible I could qualify for a partial exemption as we did rent it because we moved out of state for a job relocation, but no CPA can give me any clear cut answers to whether or not the IRS would accept a safe harbor moving exemption after 3 years. I'm not interested in doing a 1031 exchange. It pulls significant positive cash flow as a rental, but we're probably near the top of the market in terms of appreciation. Should I sell it and pay the capital gains or keep using it as a lucrative rental? I don't want to reinvest in other real estate at this time, but I would likely reinvest in stocks or other investments. Opinions? What would you do?

Michelle C. · Answer

It's an extremely good rental market still, so it's a tough choice!

Jay Jasunas · Answer

@Thomas S.

I don't think  a well maintained home or town home in a good area will run 40 - 50% of rent in repairs. In all my SFR my repairs average about 7% of rents received. I buy nice homes in nice areas. I understand the opportunity cost of the equity sitting in his home, but that could be retrieved with a cash out refinance. No need to sell and pay huge recapture and cap gains taxes.

Scott McMillan · Answer

I'm in the exact same situation @Michelle C., although with a bit less equity.  My Santa Rosa rental is coming vacant and I should be able to re-rent it for significant cash flow, however I too fear the Santa Rosa market is nearing a top, prices now are higher than they were during the bubble.  I'll probably rent it in the mean time and consider selling it in the future.

Michelle C. · Answer

No. I did remodel it when I bought it; new kitchen, new bathrooms, new appliances, new water heater. The HOA covers front yard, gutters, and roof. The backyard has some trees I maintain but that's about it. It's overall a low maintenance property.

Michelle C. · Answer

Valid points. Thanks for your time :)

Jo-Ann Lapin · Answer

Are you at this having to invest large dollars for the upkeep?

Thomas S. · Answer

"It doesn't needed any repairs" Every property will need constant repairs over the life time of ownership

Expenses and long term maintained on a home will cost on average 50% of the rental income (50% rule). You could assume less with a town home but the HOA fees will take it back up. Remember expenses happen in the future and must be accounted for today.

Assuming 40% in expenses that will leave $1140 to cover the mortgage. The remainder would be your actual positive cash flow except for the fact that you have a huge amount of dead equity.

Equity of $243K with a opportunity value of 10% is eating nearly $2100 per month in lost income...... $1140 - Mortgage = positive cash flow. Positive cash flow  - $2100 (equity opportunity value) = true cash flow.

This property is probably costing more than $1500/month in lost income making this a very poor investment property.

Michelle C. · Answer

Can you be more clear or point me towards resources to back up this claim? It's a townhouse. It doesn't needed any repairs and the HOA covers the major ones. Even when the market was at the bottom it rented for more than mortgage/HOA/taxes/insurance.

Thomas S. · Answer

A $355K property with $243K in equity with rent at $1900 can never have true positive cash flow.

You are living on borrowed time with this property and would be advised to unload it asap. This is a very poor candidate as a rental. The positive cash flow you are experiencing is temporary. Based on the value of the cash alone, forget about future repair expenses, has major negative cash flow.

You need to understand the value of cash and how expenses on a property are not based on yesterdays costs.

Sell quickly, this is a money pit that is costing you thousands of lost income.