Should I sell a massively cash-flow negative property?

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Should I sell a massively cash-flow negative property?

Ben Morris
Investor · Racine, WI · Member since 2016 · 10 posts · 0 votes

I have a property should have been a winner but ended up being an ugly monkey on my back for the last 8 years.  It currently loses about $1k/month which is about what the principle payments are (yes, there are 2).

I bought the property in 2001 for 155k.  In 2005-2008, I pulled all of the 180k in equity out and put it into a business that ultimately failed, leaving me with a property I owed more on than what it was worth.  I ended up moving out of state and turned the property into a rental.

Fast forward to today.  I am fed up with paying interest and waiting for the market, so I have been paying 2400/month towards principal and I'm finally at the point that I can sell it.  However, I'd be hit with a pretty large tax bill (fed + state around 50k) due to the equity I've pulled out.  

In my head, I have 2 options: 1) stay the course and build up equity until I can get enough to make a 1031 exchange into one or more cash-flow positive properties, or 2) sell it and pay the taxes.

My issue with #1 is time. In a few years, I can a serious amount of equity, but at what opportunity cost?

My issue with #2 is that I don't want to pay the man. In my mind, that puts me out of real estate altogether, and I want to make real estate a serious component of my portfolio.

Is there a creative option #3 that doesn't entail foreclosure (I'd have to pay those taxes) and my income is sufficient enough that I don't think they'll forgive it very easily.

Thank you!

Ben

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Dave FosterBusiness Member
Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
10y

@Ben Morris, A 1031 exchange requires you to purchase at least as much as you sell if you want to defer all tax.  It looks like your problem with that would be coming out of the sale with any cash for the next down payment.  But there are still a couple of options that may work for you.

1. A purchase of something where the owner agrees to carry the financing so you don't have to come to the table with cash for a down payment.

2. Complete your 1031 using the $40K that you've set aside to pay taxes with in  as your down payment.  

3.Do a partial exchange.  Sit down with your accountant and find a balance between a full deferral under 1031 and paying the full tax without any kind of 1031,  A compromise might be to buy something for 200K.  You'll pay the tax on 100K but shelter the tax on the other 70K.  Of course this still would require you to have resources for both the smaller tax bill and the down payment (if needed) for the replacement property.  But it's worth looking at.

If you don't have resources set aside for a potential tax bill then the 1031 exchange into a 100% owner carry property is really your only option.  I may be missing something but...

If you sell with a 1031 you've got the challenge of finding cash/financing to buy the next property but if successful you'll completely defer all tax.

If you sell without a 1031...

1. You will probably not net out 305K on your sale.  So you will come out of pocket first when you sell to cover net proceeds.

2. You will then come out of pocket again when you stroke that 40K check to the IRS (and where will that cash come from?)

Net 12 month cash out lay - probably more than 50K.  That money never comes back.

If you don't sell then... 

1. You endure a 12 month pay out of $9600 but probably get that back in principle at some point down the road.  So your annual net loss is really almost $0.

I 

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  • Patrick LiskaPro Member
    Investor · Verona, NJ · Member since 2014 · 1k+ posts · 832 votes
    10y

    You have held the property long enough to qualify for the 15% capital gains tax, ( which will be less than 15 % ) why hold it longer, it will probably end up costing you more to hold it than it will in what you would pay in taxes, get rid of it and any money you come out with, use towards another property that will give you a positive cash flow. you can do a 1031 exchange, you need to have properties already in mind. and you can not touch the sales proceeds. 

    0Reply
  • John Thedford
    Real Estate Broker · Naples, FL · Member since 2013 · 9k+ posts · 6k+ votes
    10y

    @Patrick Liska

    makes a good point about using a 1031. 
    Ask @Dave Foster his thoughts.

    0Reply
  • Carolina E.
    Investor · NW Indiana · Member since 2012 · 833 posts · 197 votes
    10y

    @Ben Morris is refiniancing an option for you, while getting it down to one payment?

    0Reply
  • Aaron Mazzrillo
    Investor · Riverside, CA · Member since 2011 · 2k+ posts · 3k+ votes
    10y

    I don't think you have provided nearly enough information for anyone to make any kind of valid suggestion. 

    You paid $155K in 2001. What did you put down? When you refinanced, what is the total new loans? You mention $180K, but we don't know if that is the total of the 1st and 2nd (you mention two loans) and if the house is worth more than that. What is the current value. 

    Why are you paying so much every month? Why not just pay the required payment and what would your negative look like then? 

    I'm no CPA, but I would have to see the details on both loans, the current value, what the rent is and how the property performs before I could make any kind of decision concerning what you are asking.

    1Reply
  • Mike D.
    Middletown, NJ · Member since 2011 · 108 posts · 22 votes
    10y

    How are you calculating your tax bill of 50k? What is it worth today?

    1Reply
  • Brandt Smith
    Cypress, TX · Member since 2016 · 132 posts · 49 votes
    10y

    @Ben Morris get that monkey off your back. You are bleeding $12k per year. 

    0Reply
  • Jeff B.
    Buy & Hold Owner · Redlands, CA · Member since 2015 · 5k+ posts · 2k+ votes
    10y

    Where's all those that keep taunting "Invest For Appreciation and not Cash Flow"???

    Sorry as all heck the OP didn't realize a profit, but the longer this goes on, the worse the opportunity costs get.  Jump out of this one with a 1031, even if it's just a few thousand and pick another horse to ride.

    1Reply
  • Ben Morris
    OP
    Investor · Racine, WI · Member since 2016 · 10 posts · 0 votes
    10y

    Thanks for all the responses and questions.  

    Financials:

    • Purchase price (2001): 155k
    • Market value: 305k
    • Mortgage balance: 300k (1st 132k, 2nd 168k)
    • Mortgage (P&I): 2100
    • Rent: 1795
    • Mgmt Fees: 142
    • Pool Maintenance: 120
    • Taxes and Insurance: 190
    • Cash flow: -800

    And how my CPA is calculating taxes (this is assuming net proceeds of 296k):

    • Basis: 125,600
    • Gain: 170,400
    • Rental activity loss carryover: 15k
    • Taxes: 39,200 (Fed: 31600, State: 7600.  50k in my original post was incorrect.  I added the state twice.)

    I have justified keeping it because the -800 cash flow is just about the principal payment every month so I figured that if I just keep paying more principal, the net result is forced savings + future appreciation + some tax benefit.  I'm having a hard time justifying paying the closing costs + taxes because once I pay them, that money is gone.

    0Reply
  • Samantha Klein
    Investor · Monroe, WI · Member since 2015 · 691 posts · 610 votes
    10y

    @Ben Morris I'm not sure why you are justifying a loss of $800 per month, that is unacceptable, you're looking for appreciation but at what cost? I understand because you basically have no equity that it's difficult to figure it out. I would get rid of this property, and 1031 into something that WILL make money every month. You're losing $800 a month now but what if something big needs replaced like the roof or a major system?

    0Reply
  • Patrick LiskaPro Member
    Investor · Verona, NJ · Member since 2014 · 1k+ posts · 832 votes
    10y

    Ben, why does your taxes seem awfully high ? - 170,000 @ 15% is 25,500 ( and it will not work out to 15%, it will be less, maybe around 12-13%). i think your CPA may be off by 10,000 on your FED tax. I'm not a CPA but i would question that.

    0Reply
  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Jeff B.:

    Where's all those that keep taunting "Invest For Appreciation and not Cash Flow"???

    we're sitting here comfortably waiting for some cash faux cheerleader to figger out about the $180,000 cash flow (appreciation) he put in his pocket.

    1Reply
  • Ben McMahonPro Member
    Investor · San Diego CA · Member since 2014 · 341 posts · 139 votes
    10y
    I know where your coming from. Besides the numbers, (which are super important) how heavy is the monkey on your back? You can always talk yourself into holding a property, but my advice would be to stop the bleeding and make money on the next one. You could flip a house and make that money back in 6 months of you are able to free up some mental space. I think it's all about your freedom again. When your weighed down, your creative juices cease and you miss out for however long you are down. My two cents is to dump the monkey and and crush your next 3 deals!!!!
    0Reply
  • Ben Morris
    OP
    Investor · Racine, WI · Member since 2016 · 10 posts · 0 votes
    10y

    @Ben McMahon I think you're absolutely correct.  It's been taking up so much headspace that it's been a virtually paralyzing, keeping me from experiencing better deals.

    BTW, I talked with my realtor this afternoon.  We're going to list the property next week.  This forum was exactly what I needed.

    0Reply
  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Ben Morris:

    @Ben McMahon I think you're absolutely correct.  It's been taking up so much headspace that it's been a virtually paralyzing, keeping me from experiencing better deals.

    BTW, I talked with my realtor this afternoon.  We're going to list the property next week.  This forum was exactly what I needed.

    So this property has appreciated about $10,000 a year, $833 a MONTH!  And you return the favor by DUMPING it.  Where is your "better" deal?  Ha Ha  Had you put down 20%, $31,000 you'd be getting 32% back just on the appreciation.

    1Reply
  • Ben Morris
    OP
    Investor · Racine, WI · Member since 2016 · 10 posts · 0 votes
    10y

    @Account Closed You're absolutely correct, it has paid me a ton in appreciation but I cashed that out 10 years ago.  Since then, I've only been paying interest on that which has eroded much the benefit I took.  Unfortunately, that benefit is gone, but that's another story.  I think I'm better off right now doing as others have suggested and dump the property and stop the month-to-month bleeding.

    Also, I don't see that rate of appreciation continuing into the future.

    0Reply
  • Patrick L.
    Real Estate Investor · Saint Petersburg, FL · Member since 2013 · 1k+ posts · 951 votes
    10y

    Also keep in mind that your monthly numbers don't even factor in vacancy loss and any repairs or cap ex for the property.   Your true monthly loss will actually be much higher over time.  

    0Reply
  • Account Closed
    Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
    10y
    Originally posted by @Ben Morris:

    @Account Closed You're absolutely correct, it has paid me a ton in appreciation but I cashed that out 10 years ago.  Since then, I've only been paying interest on that which has eroded much the benefit I took.  Unfortunately, that benefit is gone, but that's another story.  I think I'm better off right now doing as others have suggested and dump the property and stop the month-to-month bleeding.

    Also, I don't see that rate of appreciation continuing into the future.

    So what are you gaining by selling?  It seems like you will maybe need to bring money to the table and walk away with nothing.  If you keep it you will have an income earning asset.  What will it cost you to replace it?

    I wouldn't put a lot on faith in internet advice.  You also have not given enough information for an informed decision.  But do what you want.  That was your plan from the beginning correct?

    1Reply
  • Steven Loveless
    Real Estate Investor · Sachse, TX · Member since 2016 · 69 posts · 60 votes
    10y

    Looks like if you include commissions, closing costs, and taxes you will have to come to the table with over 50K to get rid of this thing.

    That's more than 5 years worth of paying $800 a month in negative cash flow. And most of that looks to be principle, so it's not really lost money, it's just increased equity. Do you think the cash flow or appreciation situation will improve over the next 5 years? If so, it sounds to me like getting rid of it is the wrong choice to make.

    If you think it will be worth less and flowing less, get rid of it. But if someone asked me if I could pay 50 grand right now or $800 a month in a deferred savings for the next decade, I'd take the latter.

    1Reply
  • Dave FosterBusiness Member
    Qualified Intermediary for 1031 Exchanges · St. Petersburg, FL · Member since 2013 · 9k+ posts · 9k+ votes
    10y

    @Ben Morris, A 1031 exchange requires you to purchase at least as much as you sell if you want to defer all tax.  It looks like your problem with that would be coming out of the sale with any cash for the next down payment.  But there are still a couple of options that may work for you.

    1. A purchase of something where the owner agrees to carry the financing so you don't have to come to the table with cash for a down payment.

    2. Complete your 1031 using the $40K that you've set aside to pay taxes with in  as your down payment.  

    3.Do a partial exchange.  Sit down with your accountant and find a balance between a full deferral under 1031 and paying the full tax without any kind of 1031,  A compromise might be to buy something for 200K.  You'll pay the tax on 100K but shelter the tax on the other 70K.  Of course this still would require you to have resources for both the smaller tax bill and the down payment (if needed) for the replacement property.  But it's worth looking at.

    If you don't have resources set aside for a potential tax bill then the 1031 exchange into a 100% owner carry property is really your only option.  I may be missing something but...

    If you sell with a 1031 you've got the challenge of finding cash/financing to buy the next property but if successful you'll completely defer all tax.

    If you sell without a 1031...

    1. You will probably not net out 305K on your sale.  So you will come out of pocket first when you sell to cover net proceeds.

    2. You will then come out of pocket again when you stroke that 40K check to the IRS (and where will that cash come from?)

    Net 12 month cash out lay - probably more than 50K.  That money never comes back.

    If you don't sell then... 

    1. You endure a 12 month pay out of $9600 but probably get that back in principle at some point down the road.  So your annual net loss is really almost $0.

    I 

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  • Mark Creason
    Real Estate Lender and Broker · Dallas, TX · Member since 2013 · 966 posts · 500 votes
    10y

    Ben,

    Is your accountant including depreciation recapture at 25% on any depreciation you have taken?

    Mark

    1Reply
  • Ben Morris
    OP
    Investor · Racine, WI · Member since 2016 · 10 posts · 0 votes
    10y

    @Mark Creason, yes he is including the recaptured depreciation.  I seem to have forgotten to include that

    0Reply
  • Ben Morris
    OP
    Investor · Racine, WI · Member since 2016 · 10 posts · 0 votes
    10y

    @Account Closed @Dave Foster @Steven Loveless  You guys all make very good points and a couple of years ago, I decided to keep the property specifically because I figured equity is better than giving it to the taxman.  I think 1031 is out of the question since the timing would have to be unbelievably perfect for it to work and I risk having to pay the tax anyways.

    I spoke with the realtor and then I spoke with my accountant again, and I think I'm going to just sit on it for now.  I'm trying to decide if I should stay the course and keep paying the 2nd down (6.125%) or go for one or more cash-flowing properties to alleviate some or all of the bleed.

    0Reply
  • Louis Swingrover
    Professional · Coeur d Alene, ID · Member since 2015 · 7 posts · 9 votes
    10y

    Hi @Ben Morris, this is only my second day on BP---nice to meet you! I have an idea that might be worth floating: 1031ing out of your cash-flow-negative property into a fractional ownership investment like a syndicated TIC or DST that can accommodate a quick close on your own timeframe. You could at least cash flow---most likely around 7%, and it would be passive. You could still take your share in the depreciation, and there may be potential for long-term appreciation. This just might solve three problems for you: 1. going from negative to positive cash flow, 2. deferring the capital gains / depreciation recapture tax hit, and 3. significantly decreasing your risk of fumbling your exchange. In fact, you could identify multiple potential replacement properties (maybe use a TIC or DST as a backup if you already have a first choice in mind) to help decrease this risk as much as possible. Here are the 1031 property ID rules you can use to your advantage:

    3-Property Rule
    ID up to 3 potential replacement properties, regardless of the aggregate market value of the properties, and acquire as many of the properties identified as desired to complete the exchange.

    200% Rule
    ID more than 3 potential replacements, as long as their aggregate market value does not exceed 200% of the market value of your current property. Acquire as many of them as you want to complete the exchange.

    95% Rule
    ID any number of replacements regardless their aggregate market value, as long as you acquire 95% of that their total value.

    @Dave Foster, correct me if I'm wrong, but I believe an exchanger only needs to replace the value of their combined equity and debt to avoid taking taxable boot? So, for example, (using round numbers) if the relinquished property had $150k in equity and $150k in debt and sold for $300k, the exchanger could theoretically pay off the debt and bring in some new capital to acquire a replacement property for $300k+ and defer the taxable recognition of the full amount of capital gain.

    Most TIC/DST offerings come pre-packaged with financing in place for leverage, so someone in a position like this one wouldn't have to come up with as much new capital (although the financing is almost never anything close to 100% loan-to-value). Someone in Ben's position would probably have to bring money to the table to reinvest, however coming out of pocket to invest is a very different thing then coming out of pocket to pay taxes!

    Interested to hear about how this all turns out. Let us know!

    0Reply
  • Steven Loveless
    Real Estate Investor · Sachse, TX · Member since 2016 · 69 posts · 60 votes
    10y

    Glad you are discussing with the pros @Ben Morris. Only advice I can give is to sit down and really look at the numbers, and what actions make the most sense. Always keep in mind the big picture, for issues like this I find an IRR calculation to really help me understand my options. My worst investment decisions have always been when I get emotional about an investment without really crunching the numbers and looking at fundamentals.

    Best of luck to you!

    0Reply
  • Martin S.
    Brooklyn, NY · Member since 2014 · 174 posts · 23 votes
    10y

    you said your business failed. so you wrote that off on your taxes right? so paying cap gains should be less than what you got in refunds. with that big of a loss you should have carry-forward the losses or even carry back and get a refund for previous years (if your tax bracket was high in those years), unless you make more than that a year and wrote it all off in 1 year... essentially, you already got the refund (if not, your accountant sucks), you just have to pay some of it back if you sell the house. why not change it to owner occupied to avoid the cap gains altogether?

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