Tax ooops on rental condo

[Michael Richardson]

Hi guys,

I'm brand new to the site, and I'm loving it.  I've learned so much in the past month - I've already listened to 80+ episodes of the podcast and spent a ton of time browsing the site - so thank you @Joshua Dorkin and @Brandon Turner for monopolizing all of my limited free time - my wife thanks you too :).  I'm starting my investment business in Louisville, KY in the near future, but this question is actually related to my rental condo I have here in San Diego, CA.  I've made a huge tax boo boo that is going to cost me tens of thousands of dollars.  Wouldn't have known about it if I hadn't learned so much on BP, but now that I have, I'm super annoyed at the situation - I guess ignorance would have been bliss - thanks a lot guys for stealing my innocence :)

The stats:

I bought a condo in 2009. It's a beautiful 2B/2BA in a nice area of San Diego (Hillcrest) in a newly constructed building (2007). I paid $405K for it - currently I'm in 7/1 ARM at 2.875% that doesn't adjust until 2020. I got married, got a dog and had a baby, so we bought a house and moved out of the condo in 2013. We've been renting the condo out (for ~$2000 - a little below market value, but not much) and losing money every month since that time - PITI is $1900 but HOA fees are $450 - it's not a big loss compared to my salary, so I was justifying it based on appreciation. And it has appreciated - it's probably up to about $500K market value - But if I've learned anything from you guys it's that cash flow is king and I should never bank on appreciation. And if I've learned anything else, it's that HOAs suck - and sure enough they just jacked up the required elevator move-in/move-out fee from $75 to $500 after the first move-in/move-out. Presumably this is to discourage rentals. So, my plan was to sell after the current lease ends and probably funnel the profit into my newly formed LLC in Louisville. Unfortunately, I just figured out that I hosed myself on taxes. If I sell by 3/16, I'd only be responsible for paying taxes on maybe $5000 after accounting for depreciation and our net losses, because I would have lived in the condo for 2 of the last 5 years. If I sell after 3/16, I'll be responsible for paying taxes on like $100,000+. And I have the mixed blessing of being in the highest tax bracket, so that will be quite a huge hit. And of course, the punchline here is that we just had someone sign a new lease through 8/16. What would you guys do? Here are the ideas I've thought of:

1) Pay the tenant to move out early - this seems cruel as they've just moved in, love the place and they're our acquaintances.

2) Find a buyer before 3/16 that would be willing to assume our tenant's lease.  Doubtful since I don't even cash flow at 2.875% on $318K left on my mortgage.  Any buyer would undoubtedly have a higher interest rate and higher principal, thus even more cash flow negative.

3) 1031 exchange - but I'm looking to use the profit in my LLC, not my personal property, so that might complicate issues? Also,even if that is OK, I'm not sure if I can bank on identifying a good property and closing long distance (San Diego to Louisville) in the required short time period.

4) Continue to hold the property despite losing money. Though I know the general BP feeling is against betting on appreciation, this property really is nice and in a great area and SoCal can be prone to impressive appreciation. I have a great interest rate on a low maintenance property with low maintenance tenants. Also the monthly loss will eventually help me on taxes when I finally do sell. But I'm recently feeling more pessimistic about this as a long term hold because the HOA looks to be getting a little power-trippy with age.

5) See if the tenants would want to buy the condo with some creative financing - I don't think they can afford it or are interested in owning though.

6) Could I sell it to my wife?  She isn't on the condo mortgage since I bought it before we got married, but we do file taxes jointly, so I'm guessing this isn't kosher.

7) Sell when their lease ends 8/16, pay the extra tax hit and chalk it up to a learning experience.

What would you guys do?  Any other creative ideas?  Thanks!  Michael