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Real Estate Math Problem... to sell or continue renting?

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  • Real Estate Math Problem... to sell or continue renting?

    Ok... since COVID, our real estate market is HOT.
    We own a payed-for rental property, fairly low maintenance, rarely get called, rent on time and deposited directly into account, been rented for 7.5 years without even one day empty.
    Replaced a water heater and microwave door handle since we started renting. Able to write off a lot for this place too.
    Across the street neighbor is in escrow for $750K with a smaller house, smaller lot, and older home.
    We might be able to get between $800-850K.
    Rent is currently under market, as we have a cap on how much we can go up with the current renters, at $2750/month ($33K/year) but we have to pay ~$5000/year in property taxes.
    Bought the property for $390K but have been depreciating for the last 7.5 years on taxes.
    Live in CA, so higher taxes, and have not lived there, so would have capital gains taxes.
    Can any math whiz figure out how much we'd pay in taxes (I figured around $190K if we had depreciated it down to $300, I'd have to check my taxes) and at what price would it be worth selling? Obviously, have to figure in real estate fees too of 6%
    The plan was always to have the rental income ($28K) to supplement our kids college funds (at ~$250K for 3 kids currently, one going off to school next year) to make sure they got through undergrad without loans. However, we have $540K on our mortgage currently, so could pay that off with proceeds and reduce our expenses by $41K/year thereby cash flowing the college supplements as needed.
    Let me know if you need more numbers to this....
    And... GO!
    TIA

  • #2
    Congrats on having an easy property. So why kill the golden goose? The paper gains are nice obviously. Q #1 - will the kids do UC/public or private? 250k for UC - not an issue. Private? Oh boy with three.

    Remember the depreciation also helps during this time too. Recapture 8 years + capital gains at ~25% (20% + income bracket).

    If you want to KIS; cash out and don't look back.

    We've kept our income real estate despite a very nice run up on paper. Cash flow if quite nice and plan to 1031 eventually during retirement for local beach home and prep for sunset years and hand over to next gen -- all depending on where the oceanfront is in 20-30 years

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    • #3
      I’m not savvy with real estate calculations but correct me if I’m wrong: basically you get 850 now if you sell, or 28 a year if continue to rent out. It would be an easy decision for me. Sell, pay off mortgage, invest the rest.

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      • #4
        Originally posted by fatlittlepig View Post
        I’m not savvy with real estate calculations but correct me if I’m wrong: basically you get 850 now if you sell, or 28 a year if continue to rent out. It would be an easy decision for me. Sell, pay off mortgage, invest the rest.
        It is already paid off; no mortgage.

        He will not take home $850k. That is the point of the post.

        Totally back of envelope:

        transaction cost, realtor fees: $80k
        Recaptured depreciation: $90k, taxes at 30% (see below) = $30k
        cap gains taxes (LTCG US, marginal bracket CA): 30% of $450k = $150k

        So $850-$260 = $590.

        So would you rather have $590k cash or $33k per year in rental income, before expenses (taxes, insurance, any utilities)?

        ​​​​​

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        • #5
          Originally posted by FIREshrink View Post

          It is already paid off; no mortgage.

          He will not take home $850k. That is the point of the post.

          Totally back of envelope:

          transaction cost, realtor fees: $80k
          Recaptured depreciation: $90k, taxes at 30% (see below) = $30k
          cap gains taxes (LTCG US, marginal bracket CA): 30% of $450k = $150k

          So $850-$260 = $590.

          So would you rather have $590k cash or $33k per year in rental income, before expenses (taxes, insurance, any utilities)?

          ​​​​​
          $590k at 4% is $23.6k.
          What’s the net rental (future)? It’s not $33k or $28k.
          You have insurance and maintenance at some point. Not sure how utilities and the major repairs will turn out. Thumbnail $5k/yr of wiggle room.

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          • #6
            Cash out 60% or about $500k. Buy another rental or two. Watch them appreciate and enjoy having other people work to put cash in your pocket.

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            • #7
              The 540k on the mortgage you're referring to, is that your personal residence or on the rental property?

              Personally, I would sell the property, do a 1031, and roll that into something that's mostly passive with a long term lease in place with a credit Tenant that's almost entirely passive with very predictable cash flows. Based on your current metrics, the ROE is pretty paltry (~9% leveraged - if the mortgage is on rental - is pretty low and that's not factoring in capital improvements, vacancy, etc.). If there is no mortgage on the rental, your ROE is REALLY bad, like ~3.3%. You could sell the house, roll it into something else, avoid cap gains and depreciation recapture, get a far better return with less risk, and it would be even more passive than what you're doing.

              It gets a little cloudier if you're only interested in either holding the current property or liquidating, since you're looking at some pretty heavy costs to go that route, between cap gains, depreciation recapture, and transaction costs.

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              • #8
                Originally posted by CREGuy View Post
                The 540k on the mortgage you're referring to, is that your personal residence or on the rental property?

                Personally, I would sell the property, do a 1031, and roll that into something that's mostly passive with a long term lease in place with a credit Tenant that's almost entirely passive with very predictable cash flows. Based on your current metrics, the ROE is pretty paltry (~9% leveraged - if the mortgage is on rental - is pretty low and that's not factoring in capital improvements, vacancy, etc.). If there is no mortgage on the rental, your ROE is REALLY bad, like ~3.3%. You could sell the house, roll it into something else, avoid cap gains and depreciation recapture, get a far better return with less risk, and it would be even more passive than what you're doing.

                It gets a little cloudier if you're only interested in either holding the current property or liquidating, since you're looking at some pretty heavy costs to go that route, between cap gains, depreciation recapture, and transaction costs.
                Mortgage is our private home. No mortgage on the rental. This was our first home, had downpayment for our current home and moved 7.5 years ago. Since then we have paid off the rental and paying down our mortgage now. It may be worth $800-850 but bought for $390K. So if you look at the cost that we bought it at and fact that we could rent it for more (under market now with current renter... but could get new renters when lease is up and raise the rent, maybe even to $3500-4000/month) in the future, doesn't seem as bad as you are making it.

                I would think our tax burden would make this something we should hold on to...

                StarTrekDoc
                Member
                StarTrekDoc Yep, told my kids I would pay for a UC education (~$35-38/year) and that is it. No loans. If they want to go private or whatever, they need scholarships or a job to make up the difference. I will have two in college in 2021 but if rental is paying ~$14K each kid, the college funds should be fine (of course we can cash flow too, if needed, but trying to pay off the mortgage!)

                Molar Mechanic
                Member
                Molar Mechanic Not sure if you can tell... but I'm debt adverse. I know some are not but I hate debt. I would rather pay it all off. So pulling money out (getting a mortgage) is not my cup of tea. I know it may not be the smartest thing but I would like to sleep well.

                FIREshrink
                Member
                FIREshrink Thanks for the calculations. ouch... 1/4 of a Million is a tough pill to swallow. Maybe my husband and I need to move back in that house (once kids are gone) and live there for two years and then sell! We could rent out our home and then move back after two years.... hummmmmm.... that would help with capitol gains!

                Thanks everyone for trying!

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                • #9
                  This is the challenge of the exit strategy of a depreciated property. Once you've enjoyed the deferred gains and depreciation it's really a bitter pill (though tax efficient).
                  CREGuy - OP doesn't want to be leveraged and that's fine too. It still works out considerably better than bonds/income stocks.

                  So the solutions become:
                  1. 1031 exchange into something family enjoys and step up at death
                  2. Move back to house for 2 of 5 years -- max $500k at this time so it needs to be soon.

                  Our long term strategy for our reside

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                  • #10
                    I get not wanting to pay 200-250 thousand in taxes- but you also end up with half a million with no more hassle that you can then invest. If you won a 500k jackpot in the lottery- would you rather take a lump sum or spread it over 30 years?
                    I think it really boils down to do you want to remain a landlord or not- If so, then yes keep or 1031 to another property. If you're not gung-ho about being a landlord, I'd take the money lump sum while the appreciated value is so high. I would not go through moving twice just to avoid capital gains taxes, but thats just me.

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                    • #11
                      One other thought that's a bit different path... Is there anywhere you'd like to own a vacation home or eventually retire to? You could always sell the rental home and 1031 into a vacation rental, rent it out for a year or two, then you could simply stop renting it and make it your primary home or vacation home. There's no way to determine what your return would be in this hypothetical, but it does save you the transaction costs if you were to go this route. Really it likely only makes sense if a vacation home or a relocation in retirement is something you want anyways, but something to consider if that is the case. You would also owe some cap gains most likely on your current home but you'd get the exclusion and wouldn't have to recapture any depreciation, so you're going to likely come out ahead on that front. You wouldn't even have to do this now, you could always do it down the road as well...

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                      • #12
                        If the tenants/property were a PITA, it would be an easy decision. It is more than a math problem, it also requires some forecasting, discussion of diversification, consideration of whole portfolio, risk tolerance, irritation tolerance, future usefulness.

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                        • #13
                          Originally posted by CREGuy View Post
                          One other thought that's a bit different path... Is there anywhere you'd like to own a vacation home or eventually retire to? You could always sell the rental home and 1031 into a vacation rental, rent it out for a year or two, then you could simply stop renting it and make it your primary home or vacation home. There's no way to determine what your return would be in this hypothetical, but it does save you the transaction costs if you were to go this route. Really it likely only makes sense if a vacation home or a relocation in retirement is something you want anyways, but something to consider if that is the case. You would also owe some cap gains most likely on your current home but you'd get the exclusion and wouldn't have to recapture any depreciation, so you're going to likely come out ahead on that front. You wouldn't even have to do this now, you could always do it down the road as well...
                          We currently own (kind of... two have mortgages but both have a lot of equity in them) three properties (our home, the rental and another home my mom lives in) that are all in a "vacation" area where lots and lots of people have their second homes. Lucky for us... we have made a living where others wish they could be (hence the spike in prices right now, especially with virtual schools). I doubt we'd go anywhere... wouldn't mind owning multifamily real estate (4-6plex) but doubt we could afford without a ton more in debt... which we don't really want to do.

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                          • #14
                            Sounds like we're on similar tracks but we're a bit heavier in the RE (50% of total NW). Primary house with mortgage. 2 houses with parents/inlaws and a few income properties that are free and clear and have appreciated over 150% since the 2007 bust. Luckily only 1 launching but she's eyeing private school though looking more seriously at UCLA and SLO thankfully.

                            No bad choices here. Depends on how you like to slice your pizza.

                            I would keep it since it does appear like a nice reject button property.

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                            • #15
                              Originally posted by StarTrekDoc View Post
                              Sounds like we're on similar tracks but we're a bit heavier in the RE (50% of total NW). Primary house with mortgage. 2 houses with parents/inlaws and a few income properties that are free and clear and have appreciated over 150% since the 2007 bust. Luckily only 1 launching but she's eyeing private school though looking more seriously at UCLA and SLO thankfully.

                              No bad choices here. Depends on how you like to slice your pizza.

                              I would keep it since it does appear like a nice reject button property.
                              Yep, mine is looking at UCSD, UCLA, UCSB, UCD, Cal, and SLO. Maybe our paths will cross.

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