Are my investments sound

[Brad Rondeau]

Hello, I continue to question my investment in Laguna Niguel CA. I purchased a 3 bdrm condo for $365,000 in Dec 2009 with 20% down. I now have a 4% loan but pay $280 in HOA fees monthly. I did about $16,000 in improvements - paint, carpet, remodel kitchen etc. I lived in it for one year and then started renting in Jan 2011. I started renting at $2,175 and next month the rent will be raised another $95 to $2,340.

Looking at my 2013 Schedule E, I made $26,700 in rents and show Total expenses as $28,107 (depreciation, taxes, interest, repairs, gas). Repairs/maint are very low each year around $300 (maybe one plumber or pest control visit each year). Unfortunately because I earn to much I write off any of the loss. So I have a small negative each month but the house has risen according to zillow to $465,000. I expect the appreciation now to slow. I expect to have a small negative or maybe break even. I know I should have a positive cash flow but this will take more years of rental increases. I've had the same tenants for over 3 years and they are great. I see other investors with huge cash flows but I can't even break even or get tax advantages from loses. Would I be able to take these tax loses if I got a real estate license (would be a real estate professional). Does it make sense to keep this or sell next May when the lease is over? I'm nervous about taxes and don't know how it works since I lived in it for one year before renting. This property is held in my trust but wonder if I incorporated - would this help me tax wise.

Also, it seems it is impossible to buy a property in southern California and see it flow cash as mortgage payments are way over the monthly rent. Is this a terrible place to be a realestate investor?

[Jon Holdman]

If you're buying for cash flow paying $365K for $2340 in rent is a terrible deal.

There may well be an appreciation play, though, if you can sustain the negative cash flow.

Getting a real estate license has no effect whatsoever on being a "real estate professional" for tax purposes. To be a real estate professional you need to spend at least 750 hours per year doing real estate tasks AND you need to spend more hours on that than anything else. So, if you have a full time job you have to spend 2081 hours per year on real estate.

You're actually much deeper in the hole than you think. If you have a lengthy eviction, a vacancy, an HOA special assessment or any other sort of big expense you'll be out of pocket.

You can sell with a tenant in place, though you will widen your pool of buyers if its empty and its a place that would sell to an owner occupant.

If you only lived there one year its not enough to qualify for the homeowner exclusion for capital gains. For that you need to have lived in it for two of the five years immediately prior to the sale.

Taxes on the sale of a rental may be higher than you expect. Your basis goes down with depreciation. The amount of gain up to the amount of depreciation (actually taken or allowed, whichever is greater) is subject to a tax on unrecpatured depreciation, currently 25%. Any remaining gain would be long term capital gains, currently 15%. Good news is that those passive losses you couldn't take can be applied to the sale and will reduce your taxable gain.