Is there an upside to this situation?

Question

Can't sell our residence in MN and are forced to rent it. Cash flow is break-even or slightly negative if I rent it out. Can you help me understand the tax benefits?

Monthly outgo: $840 PITI + $110 Property Management + $50 water bill
Monthly income: $1000

Mortgage remaining: $99,900
Tax assessed value: $115,000

I am feeling terrible about having to rent it out due to the break-even cash flow + the uncertainty of big expenditures.

But will I realize any other of the standard Real Estate benefits?
1) Cash Flow
2) Appreciation
3) Equity
4) Tax advantages

Many thanks. I feel stupid for not knowing how to figure the tax stuff. This would be my second rental property but I am a novice.

Brian in St. Cloud MN

Jon Holdman · Answer

Yesterday I wrote a check for $1300.  In the next day or two I'll write another one for another $3000-5000.  All for replacing a sewer line.  I knew it was coming and I'm prepared for it, but its still unpleasant to pay out that money.  But if your tenant can't flush their toilet, you do what it takes to resolve that.  We will see what everyone involved has to say tomorrow.  That single expense will consume for 53% of my rents for the year on that property.  But the tenants been there for over a year and a half, pay like clockwork, and doesn't cause any problems at all.

Fortunately, that's the biggest single bill I've since buying my rentals.  Unfortunately, bills for a few hundred are a not-so-uncommon occurrence.  Even though you think your house is in good condition, things still pop up that contribute to that 50%.

With only a $6000 loss (are you accounting for all the commissions, closing costs and potential concessions to the buyer?) I'd consider selling.  Percentage wise, I've took bigger losses to escape from a bad deal.

Michael Seeker · Answer

$6K loss is not bad at all.  Depending on your financial picture it may seem like a lot, but you're opening yourself up to the likelihood of losing MUCH more than $6K as a landlord with this property.

I'd cut your losses and move on - a $6K loss is not worth becoming an accidental, out-of-town landlord!

Brian Mathews · Answer

It sounds to me like you're in no mood to be a landlord and mess with long distance landlording.  Especially with deadbeat tenants.  I might just take the $6000 hit and move on for peace of mind.   One nasty or screwed up tenant and you'll be halfway to $6000 in repairs alone.  One busted furnace and you're already there.

Jon Holdman · Answer

You're quite a ways from breaking even.  Not sure how much of that PITI is P&I, but you've omitted capital, vacancy, maintenance (mostly caused by tenants), other utilities (at least when its vacant), make ready, legal costs, CPA costs, etc.

Landlord insurance is more expensive than homeowners.

As far as the tax benefits, your net rental income will be the rent you actually collect, less all actual expenses (taxes, insurance, PM, maintenance, utilities, etc.), less interest (not the principle payment, though) and less depreciation.  Depreciation is based on the value when you convert it to a rental, so you'll need to figure that out.  Its not the tax appraisal, though you can use the tax appraisal to split improvements from land.   Assuming an 80/20 split and using the tax assessment value (you can't, just doing this to give you a number), your improvements are valued at about $92,000.  So a full years depreciation is $3345 or $279 a month.  So, that will almost certainly put you in a passive loss situation.

Now, to tell you the effect, you need to look at your AGI.  Under $100,000?  You can offset other income with the passive loss.  Over $150,000?  Nope.  In between, the $25,000 special allowance phases out by $1 for every $2 of AGI over $100K.

Sounds like you don't have a CPA.  You really do need one if you're going to have rentals.

If you sell now, how much of a loss will you take?   If you hang on, what's your monthly loss?  I'd just use the 50% rule (50% of gross rents go toward expenses, capital and vacancy).  That gives you NOI of $500.  Subtract your P&I.  That's your monthly loss.  If you actually get any tax benefits, I suppose you could add back in to reduce the loss.  Now, consider when you might actually sell.  Which plan hurts less?

Also realize that when you do sell, the depreciation comes back to bite.  As you take the deprecation your basis goes down by that amount.  That means the gain when you sell is greater.  Further, the total of the deprecation you've taken (or you were allowed to take, if that's greater) becomes "unrecaptured depreciation" and you pay tax on that at a higher rate.  Currently that's 25%.

Also keep in mind that if you do end up with a gain, and you lived in it for two of the five years before the sale, you can avoid any tax on the gain at all.  If that doesn't apply, its all gains.

Stephanie Dupuis · Answer

We also have lien issues for utilities - I get around this is in one of two ways depending on the property:

1. charge a $40-$50/mo utility fee per person in the unit. Nobody has ever blinked an eye at this.

2. Utilities that can lien in our state are required to send a notice to LL when a tenant does not pay on time. For this to work, the LL must call the utility and have them set this up. I'll have tenants pay water and garbage (both lienable utilities), but I am notified if (as soon as) they are not paid in order to prevent a lien. My lease states that failure to pay utilities is cause for eviction (just like failure to pay rent). It's only happened once, I contacted tenant and they paid next day.

Looking at your situation, though, I'd sell and take the loss. Make sure you've accounted for all costs (commissions, pest certificates, closing costs, seller concessions that are custom in your area, etc.).

Michael D. · Answer

Yes, please learn from my pain. Sell it. You can always become a landlord later with a property that actually has cash flow.

Brian Knox · Answer

Great info from you all:
John Rubino:Would the lease option to buy be like C for D? or Rent to Own? Yes, totally open to that.
Curt Smith: helpful points!
Jon Holdman: I love that you don't candy coat. You are blunt and, consequently, helpful. If we sell the house now, we lose $6000 after all closing fees.
W2 Income: way under $100,000
How do I figure out the remaining value to depreciate?
50% rule: Yeah, losing about $300 per month. This is nasty.
Other input?
Steve Babiak: #2. Absolutely. All sorts of landlords in St. Cloud getting 
"special assessments" due to their deadbeat tenants.
Brian Mathews: Job transfer and cross-country move (due to MN climate and proximity to grandparents). St. Cloud market is inching up, but slowly and not right in our neighborhood.

Open to all input. Be blunt with me.

Brian Mathews · Answer

Why are you leaving your house?  Job transfer?  How's the market there?  I'll guess not good.

Steve Babiak · Answer

Why are you paying the water bill?  The only good reasons are 1) it is a multi-unit building with only one water meter ; and 2) the water utility can put a lien against the owner for unpaid water bills even though the tenant was  the one named on the bill.

Curt Smith · Answer

Brian, you'll be able to do a taxwise conversion of a prior primary residence to a rental and start depreciation.  Your fix up costs up to 6 months prior to conversion are (I believe) can be considered fixup capitalization or expense depending on what you did.  It'll help negate some of your W2 income and you'll probably do fine.  This is a great time to start a landlording business.  Just do a good renter check of the renter.  Which is where accidental landlords go wrong by letting in some professional renter.

I use http://www.ctcredit.net   Everyone has low fico and tons of debt.  I look for all green on the on-time payments.  Their paycheck being 3-4 x your rent.

- I screen for long term, kids to stay in the high school etc.
- I specifically ask: why this house and not the prior house you saw.  I select for special reasons why they have to have my house.
- I walk out to their car and make sure it's neat, messy car they'll wreck your house.
- I schedule an odd meeting time like 1:15 Sat and say I'll only be there for 1/2 hr.  No shows self edit in my process.
- No big dogs, no exceptions.  I just lived through this mistake!!
- Get some local REI guys lease crafted per local laws, not the off the internet lease.
- Use postlets.com to push to every rental site except craigslist, and craigslist, lots of pictures are a must these days.

There's good helps in the BP landlording groups I suspect.  Your local REIA probably have landlording classes.

curt

Is there an upside to this situation?

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