Dear Tax Talk, We have a house that we bought from a bank in January of 2010 for $375,000 (at 5.375% interest), approximately $50,000 undervalue for the property, that we live in currently. It was financed by Veterans Affairs.
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In January of 2014, my job will take us out of this state, and we face either selling or renting. Reasonable real estate estimates are that we can sell around the $400,000 mark, enabling minimal profit after fees.
Conversely, due to our location we can easily rent to foreign nationals who have a high desire to be in our community at their monthly per diem rate of $2,000. From a tax standpoint, is it better to:
A. Sell at minimum profit?
B. Convert the house to investment property and rent with the associated depreciation rules?
C. Rent without converting to investment property and sell in four years when the market has presumably improved so we can enjoy a bigger capital gain exclusion?
I plan to visit our accountant with these questions, but I want to sound minimally intelligent when we make that visit. Thanks! -- Mike
Dear Mike, I usually recommend selling your home when there is substantial appreciation, and you qualify for the main home capital gain exclusion of $250,000 for singles or $500,000 for married couples. However, in your case you don't have that much inherent gain if you switch over to rental.
With a $350,000 mortgage, you're probably paying more in principal, interest, taxes and insurance, or PITI, than the $2,000 a month you would get from rent. Since you'll be in another state, you'll have to rely on others for repairs and finding tenants, which will add to your losses. While some investors are willing to lose a little cash each month, it only makes sense if you expect bigger increases in value than monthly out-of-pocket expenses. In other words, you might be willing to lose $2,000 in cash each year if the value increases by $5,000 or more.
You might have some tax benefits for depreciating the old house. However, these benefits are only a deferral, since when you sell the home, you have to pay tax on the recovered depreciation. So your option to sell might be the best choice.
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