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Selling a rental can have big impact on your tax liability


Selling your house? Beware of tax liabilitiesSorry to write about the rentals again today. It’s just consuming all my attention and I’m having a hard time thinking about anything else. We decided to put our rental home and 4-plex up for sale to take advantage of the HOT real estate market. I know we’d have to pay tax on the gain, but I didn’t realize just how much tax we’d have to pay.

*Here is something new – I’m going to give real estate crowdfunding a try this year. I opened an account at Realty Shares in January and invested $8,000 in a commercial property in Arizona. The ROI for this project is estimated to be 17% annually over 3 years. That’s amazing and I’m anxious to see if they can deliver. This ROI estimate is quite high. Check them out if you want to invest in real estate, but don’t want to be a landlord.

A Big Tax Bill

I just finished our tax return with 3 days to spare. Whew! This year we don’t have to pay much tax at all because we came in under the 15% tax bracket as planned. The upshot of this is our dividend income last year was tax free. Yes! That’s what I love about dividend investing. If you file as married jointly and your taxable income is under $72,500, then your dividend income is not taxed.

Once our tax was done, I modeled how much tax we’d have to pay by putting in the projected sales info. Well, imagine how you would feel if next year’s tax bill will be $47,000 higher (federal and state combined). With the capital gain from the rentals, our income would shoot into the 33% tax bracket and we’d have to pay a lot more tax next year.

Here is the info on the rentals.

Rentals Cost Projected Sale Price Mortgage Owed Taxable Gain Additional Tax next April
4-plex $305,000 $380,000 $216,000 $50,000 +$17,000
House $215,000 $345,000 $70,000 $107,000 +$30,000

This is assuming we sell the 4-plex first, then the rental home. The income would get added on top of one another and push us up the tax bracket. I can stomach selling the 4-plex and pay the tax, but the rental home just increases our taxable income too much. It’s almost cheaper to just hold the house for 2 years, then sell it as a primary residence to avoid such a huge tax bill.

Yeah, I know. It’s a first world problem, but that is A LOT of tax. So what are our options?

1. Sell our condo and move into our old house for a couple of years.

This would be the most financially beneficial move. Our old house is the perfect size for us right now. If we live there for 2 years, we won’t have to pay tax on the capital gain when we sell (up to $500,000 gain for a married couple.) We don’t owe much mortgage and our monthly housing cost would reduce quite a bit. We also won’t have any gain from selling our condo, so that won’t affect the tax.

However, the house is not conveniently located. Mrs. RB40 would have to commute for over 2 hours per day on the light rail. Right now, she gets home around 5:30 pm and it’s perfect. If we moved back to the suburb, she’d get home around 6:30 pm (and later when she works late) and we won’t get to spend as much time as a whole family. That’s a huge problem.

We also like living in downtown Portland. It suits us much more than the suburb.

*update* The new rule states that the profit will be prorated depending on how much you used the home as a primary residence. So if we live in the home for 2 out of the last 5 years before we sell it, then we will still have to pay tax on 60% of the gain. We also have to pay 25% on any depreciation taken.

2. Just sell the 4-plex. Keep the house and the condo.

As mentioned above, it’s almost cheaper to just keep the house and convert it to our primary residence than to pay the additional $30,000 in tax. We could live in our condo during the weekdays and live in the house during the weekends and vacations. For tax purpose, the house will be our primary residence and the condo will be our second home.

This would eliminate the commute problem for Mrs. RB40. We’d have the best of both worlds. Of course, it would be painful to pay 2 mortgages and utility bills. Our monthly housing cost would be nuts and our monthly cash flow would be shot to pieces.

3. 1031 exchange the rental home

Basically, you can defer the capital gain tax if you roll the money over to another investment property. I did some research a few weeks ago and discounted it mainly because we have 2 rental properties. Doing a 1031 exchange would be a lot of headache for us for the following reasons.

Timeline – We’d have to buy a new home in this hot market and the timeline is tight. You have 45 days from the closing date of the first property to identify a new home and 180 days to close.

The right property – It’s going to be tough to find the right property right now. The inventory is extremely low in our area. Mrs. RB40 is reluctant to buy if it’s not the perfect place, or at least, close to it. We’d rent it out for a few years and then move in. The plan is we’d live there until RB40 Jr. graduates high school in 15 years or so.

Target value – The target value needs to be equal or greater than the properties you’re exchanging. Basically, you have to pay tax on any money you receive from the deal OR any reduction in mortgage. If we exchange both properties, then we’d have to find a place that cost $750,000 AND get a $300,000 mortgage. I don’t want to get a big expensive home because we’d have to pay more property tax, utilities, and insurance.

Mortgage – Now that I’m self employed, I’m no longer a good customer for the banks, especially for investment properties. I’ll need to go talk to my bank and see what they can do for us. I doubt they would lend us $300,000 for a rental property. However, I’m pretty sure we can borrow $70,000. This is why I think it’s probably better to do the 1031 exchange on only the rental home.

Landlord – One of the reasons why I’m selling is because I’m tired of being a landlord. Do I really want to deal with another rental? I’ll definitely hire a property manager if we can pull off the 1031 exchange.

I talked to a 1031 exchange specialist and she told me it will cost about $1,000 to do the exchange for one property. The cost is a little more as you add more properties to the exchange. That’s not too bad if it all works out.

I think the best option for us right now is to do the 1031 exchange only on the rental home. We’d avoid the biggest tax hit and it would be easier to find the right replacement property. If we can’t find the right property in time, then we’d just bite the bullet and pay the big tax bill next year.

4. Other alternatives

There are more hair brained alternatives that I already gave up on.

  • 1031 exchange both properties into an owner occupy 4-plex nearby. More landlord fun…
  • Move to rental home and rent out condo. Long commute and probably won’t make any money with the condo rental.
  • Just sell everything and move to Santa Barbara. Except Mrs. RB40 can’t find a job there…
  • Keep both rentals. Probably a good idea financially, but I don’t want to be a landlord right now…
  • Sell the 4-plex and keep renting the rental home.
  • Just pay the tax and be done with it. This isn’t a bad option at all. We’ll pay a big tax bill next year, but after that our tax bill will be reasonable for years to come.
  • Any suggestions? I’m losing serious sleep over this whole process.

So that’s why I’m all stressed out lately. At this point, I’m going to go with option 3 and do a 1031 exchange just with the rental home. It will be a lot of work and more stress, but it’s the one that make the most sense to me.

Tax is why it’s better to think long term with investment properties. Whenever you sell, you’ll have a huge tax bill and all kind of fees to deal with. It’s better to keep it and enjoy the rental income if you can handle being a landlord. I’m open to suggestions so let me know what you think we should do.

Disclaimer: I’m not a tax expert so I might have some mistakes.

{ 68 comments… add one }
  • so April 14, 2014, 4:33 am

    Option 3 is straight-up misguided. You don’t want to be a landlord, which is what initially prompted the sales, so you are going to 1031 and continue being a landlord (and add the stress of getting to know the new property / the time restrictions?) There are no good half-measures, if you want to get out of the landlord game, get out, don’t fiddle around.

    I would also point out that you have to pay taxes on depreciation recapture even if you move back into the rental house, so it’s not a tax-free sale. Try to find other deductions / credits (I would clean out the two rentals and give everything not nailed down to goodwill for a non-cash charitable contribution, for instance).

    Anyways, it looks like you have enough liquid to pay the tax at year end, so bite the bullet and be out of the landlord business. You are letting the tax tail wag the dog and it is compromising your judgment.

    • retirebyforty April 14, 2014, 9:37 am

      Thanks for your input. Actually, the depreciation isn’t that much on the rental house. The initial cost was pretty low so we couldn’t depreciate much over the years. Yeah, we should have enough liquidity to pay the whole tax bill without too much problem. I just hate to write a big check like that to the IRS. I think you’re right about letting this compromise my judgement. I’ll work on it more.

  • Crass Cash April 14, 2014, 5:32 am

    You might want to look into #1 again. According to the tax class I just took there will still be tax ramifications if you move back into the rental. I’ve heard this stated many many times and it’s false according to my tax professor. Best of luck!

    • retirebyforty April 14, 2014, 9:40 am

      You’re right. I will update the article.

  • [email protected] April 14, 2014, 5:35 am

    That’s crazy! I’ve never looked at how much we would pay if we sold ours, so this is definitely eye-opening. I do think we’ll keep ours for the long run but you never know.

    • retirebyforty April 14, 2014, 9:46 am

      Yeah, it’s nuts. That’s a big bill. The IRS will take a huge bite of any profit we made.

  • Justin @ Root of Good April 14, 2014, 6:20 am

    Joe, I’m glad you’re highlighting the tax implications that occur when you dispose of a rental. That’s one part of the rental game that scares me! I’m used to having a lot of control over how many capital gains I realize when I sell appreciated securities, and I can choose tax lots carefully to gain a lot (if I want to fill up my 0% bracket) or gain little or lose some ($3,000 capital loss write-off against ordinary income).

    The thought of a looming $50,000 or $100,000 capital gain (that I would owe tax on at my marginal rate) is a hard pill to swallow.

    I didn’t catch this in the article, but did you consider the depreciation recapture in your gains calculation for your chart? Rentals are depreciated by a few percent each year (which makes rental real estate very tax friendly while you’re collecting rent!). That reduces your basis. Your 4 plex cost of $305,000 is your basis, minus any amounts depreciated. So you might have more gains than you realize if depreciation significantly lowers your basis well below your purchase price.

    • retirebyforty April 14, 2014, 9:48 am

      Yes, the Turbo Tax took depreciation into account. The 4 plex didn’t have a lot of depreciation because we only had it for a few years. The rental home’s initial cost was pretty low so we couldn’t depreciate much every year. We’ll have to pay 25% tax on any depreciation taken. There is no way to avoid that.

  • nicoleandmaggie April 14, 2014, 6:27 am

    Ugh, dabbling in real estate sounds even more unpleasant!

    My dad once donated a rental house (to the local university) so as not to have to deal with all of this. There were some additional complications (like a murder), but that’s another way to not have to deal with taxes. 🙂

    • retirebyforty April 14, 2014, 9:49 am

      That’s a great way to dispose of a property. Thanks for the idea, but we’d probably just pay the tax and take some profit. We’re not that rich yet. 🙂

  • Tyler April 14, 2014, 6:41 am

    Have you considered just hiring a property management company to handle the day to day operations of the properties? That could fit in to the 1031 exchange option as well. It would also avoid the tax problem, continue to generate income from the properties, and alleviate a lot of the stress of being a landlord.

    • retirebyforty April 14, 2014, 9:50 am

      We have a property manager for the 4-plex. It’s much less stressful. If we get another rental, we’d definitely get a property manager.

  • Raky Patel April 14, 2014, 7:01 am

    Keep both rentals! Just get a property manager to handle it. I have a rental and though it is 8.5% a month, it is very hands off. Plus the cost of the property manager is tax deductible. You will continue to get all the benefits of owning investment property (cash flow, equity capture, appreciation, depreciation, etc…) plus you won’t have to pay that big tax bill.

  • Leigh April 14, 2014, 7:10 am

    I think the way I would look at it is that you just set aside the tax amount from the proceeds of the sale and you get a bit less back since you guys want to get out of the landlord business. I mean, you will get over $150,000 in extra proceeds than you had paid into the places, so just pay the tax out of that mentally and it won’t seem like as big of a deal. Instead of getting $157,000 extra, you’ll only get $110,000 extra. Still seems like a sweet deal to me.

    • retirebyforty April 14, 2014, 9:52 am

      That’s a good way to look at it. It’s easiest to just pay the tax and be done with it.

  • SavvyFinancialLatina April 14, 2014, 7:15 am

    Holy moly…talk about not an easy way to get out of the rental business. Makes you rethink being a landlord if you are not in it for the long term.

    • retirebyforty April 14, 2014, 9:53 am

      Yeah, uncle Sam is tough.

  • Moon April 14, 2014, 7:47 am

    I haven’t been in the rental properties business long so my question probably doesn’t even make sense. But I figure before you quit your job your household made well over $150K a year therefore the ‘loss’ couldn’t get deducted from your tax for the past few years? I think you might have lost some money on your 4 plex due to all the repairs and all the related expenses. From my research and what my CPA told me the ‘loss’ accumulates and can roll over for deduction when your income thershold is lower than $100K again (or when you sell). Will it help lower your taxable gain?

    • retirebyforty April 14, 2014, 9:54 am

      I was able to take most of the accumulated loss for 2013 because our income was pretty low. So that’s mostly gone. It won’t offset the profit from the sale. 🙁

  • Anon E. Mouse April 14, 2014, 8:36 am

    On the one hand, owing tax because you’ve got a big capital gain is a good problem. Yes, there are costs to getting out of an after-tax investment. That’s true, of course, whether it’s a rental or a mutual fund.

    I agree with commenter ‘so’ above. You want to get out of rentals, and recognizing your taxable gain is the cost of doing that.

    • retirebyforty April 14, 2014, 9:55 am

      You’re right. Usually, we don’t realize a huge gain with the stock market, though. I sell a little bit every year to avoid the big tax bill.

  • Joe C. April 14, 2014, 8:47 am

    I would sell the 4-Plex and keep the house.

    Not knowing your exact history, I would think the 4-Plex is what causes more of the landlord headache then the single family detached. I’m also thinking that you might see continued increase in the value of the single family detached at a higher rate then the 4-Plex and even though it will increase your tax later, at least you have an even greater gain.

    • retirebyforty April 14, 2014, 9:57 am

      I have a property manager for the 4-plex. There are more problems, but the property managers absorb a lot of that. They do cost quite a bit and that’s why we don’t cash flow very well with the 4-plex. I don’t know about the rate of gain. Right now, investment properties haven’t gained much. The single family homes went up quite a bit over the last few years.

  • Pretired Nick April 14, 2014, 9:14 am

    We just completed our taxes after selling my fourplex last year and I totally scored. I had tons of deferred losses so my tax hit was negligible. Next year could be an issue since I sold another property this year but it was still worth it to drop that thing while the market was still hot.
    My take for you, Joe, is to focus less on the exact dollar pain and focus more on setting up your life the way you want it. A hit of $17,000 isn’t really that bad if you’ve had significant gains. If you refocus your thinking on the positive side of the balance sheet, this will feel like a small blip when you look back on it.

    • retirebyforty April 14, 2014, 9:59 am

      Nice! We already used up most of our deferred losses for 2013 so there is not much to offset next year. $17k isn’t too bad. It’s the additional $30k that I’m stuck on. It’s a good idea to focus on the positive, though. Thanks. Mrs. RB40 will appreciate this.

  • Ravi April 14, 2014, 9:20 am

    Pay the tax gain and be done with it. No free lunches in this country… especially not with the IRS.

    If you’re willing to hold on and get a good property manager, then that’s the whole benefit of owning real estate. You can defer taxes for quite a while on the rent (due to opex and depreciation), but of course the depreciation recapture upon sale stinks. It’s easier to stomach a $40K tax bill when you realize it’s really 3-4 years of taxes combined PLUS the compounded returns you earned on the deferred taxes for each year.

    • retirebyforty April 14, 2014, 10:00 am

      There are free lunch. 🙂 You just have to know how to play the game.
      You’re right, though. Paying the tax and just be done with it is a very good option.

  • Financial Samurai April 14, 2014, 9:26 am

    Congrats on your gain.

  • Jane April 14, 2014, 9:51 am

    Hello Mr. RB40!,

    I enjoy your blog.

    I would like to add that by waiting to sell, you are taking on the risk that the market will have cooled by the time you are ready to sell the properties. Your tax on the gains (if there are any) would be lower then, but I’m sure that’s not what you want. By trying to save money short term, you could be losing it long term.

    Also, by holding off on selling to defer the taxes, you are also deferring the gains you would earn on the proceeds of the sales. How long would it take you to earn back the taxes in your dividend account with the additional money, I wonder?

    You have mentioned that Mrs. RB40 would also like to be out of the rental business, and she hates filling out the paperwork. Option #3 is just more of that. I would consider the taxes as the cost of simplifying your life and getting rid of a ton of stress. Sometimes you don’t realize how much stress you are under until it is gone. Peace of mind is worth a one time cost for a long term benefit. That’s what saving is all about, right?

  • C. April 14, 2014, 10:17 am

    I agree with above commentator “get your life the way you want it”. Keep the Mrs happy, commute is bad. Focus on positive gain.
    Only other idea I have is could you sell 4 plex now & home next year? The rental home just started generating a nice income which could pay for property manager.
    You should be in school district you want when Jr starts kindergarten in my opinion.

    • retirebyforty April 14, 2014, 1:59 pm

      Thanks. I will try to focus on the positive. 🙂 Selling one property per year would probably be okay. I have to investigate the tax impact more. We are in a good school district now and we don’t want to move out of it.

  • Joe C. April 14, 2014, 10:34 am

    Not that this eases the pain, but my wife who’s a CPA always says, “It’s a privilege to pay taxes.” Not sure is that’s some old accounting line they tell their clients.

    • retirebyforty April 14, 2014, 2:00 pm

      Heh, thanks for that. I should be thankful that we made money instead of losing money and getting some tax deduction…

  • Cindy @ GrowingHerWorth April 14, 2014, 10:37 am

    I hadn’t ever thought of the tax implications of selling a rental. I personally can’t see myself being a landlord, but I’m on the line right now on whether it’s a better idea to rent out or sell my house. I’m kind of willing to take a loss to get out from under it, so I could see being willing to pay the taxes if I were in your case.

    Building on what someone above said about reducing your taxable income (through donations); Given that you’re self employed, could you funnel more of your income into a retirement account? I know people who are self employed have options available that enable them to invest more of their income than the standard amount for 401 k’s and IRA’s. On the plus side, it would decrease your tax bill. On the minus side, it would tie up more money into retirement, instead of where you originally intended the money to go (your future home?).

    • retirebyforty April 14, 2014, 2:01 pm

      I already put most of my self employment income into an i401k. It’s helpful, but the extra income from selling the rentals is too much to overcome. I guess I could give a big donation…

      • Barbara Bailey May 5, 2015, 9:20 am

        You can gift up to $10,000 tax free. Can you gift this amount to your child, setting it up in a trust fund for college? This would reduce your income while still saving for your family’s future needs. Would it reduce your tax liability on the rental sale?

        • retirebyforty May 5, 2015, 9:31 am

          Actually, the gift limit is now $14,000. It doesn’t reduce your income tax, though.
          We contributed to the 529 and that reduced our state income tax a little. I’m not sure if a trust fund is the right way to go for college funding. I don’t think there are any tax advantage to it. Probably better off with a combination of 529 and Coverdell.
          I’m not a tax expert so you probably should talk to a tax advisor.

  • mike April 14, 2014, 10:49 am

    Hi Joe:

    I agreed with what everyone above said about just selling both and take the tax hit. Your family sounds like the type that likes and wants less complication. I think selling both and not fumbling around with a 1031 is definitely the way to go.
    You should look at it this way, if you have to pay a ton of taxes on a gain, it means you made a big gain. IN my book that is way better than take a big tax deduction for big loss.

    By the way, what does your wife do for a living.? I thought she was a pharmacist. I would think she could find a job always anywhere. PPl need their meds.


    • retirebyforty April 14, 2014, 2:02 pm

      Mrs. RB40 needs much less complication these days. Thanks for your input. Mrs. RB40 is in HR. Not that many jobs in SB. Mostly hospitality businesses. Pharmacist would be able to find a job pretty easily.

  • Max April 14, 2014, 11:21 am

    Hey Joe,

    I had thought that you were going through this process a little care-free in regards to taxes.

    It sounds to me like you want to get out of being a landlord, personally I’ve been enjoying it so far but it is definitely a little bit of extra work and headaches here and there.

    I’d recommend 1031 exchange if you don’t think your current properties are working out and look outside of Portland. There are a lot of turn-key property management companies out there with the extra money you had you’d be able to get some good returns. You’d have to feel comfortable owning property outside of the area though and the challenges that come with that. I haven’t done it yet, but it’s something I’ve been increasingly considering. With the amount of the sales, you probably could get some cheap out of state properties all cash without having to get a mortgage….

    And if you’re getting an additional $157k in taxable gains perhaps you or your spouse can just work less (quit your jobs for a while) to off-set some of the incoming extra income.

    Best of luck

    • retirebyforty April 14, 2014, 2:04 pm

      You’re right. I was a bit careless in the beginning. I thought I’d just pay the tax and I didn’t know that it would be that big… Next year I’ll definitely get a tax accountant. I already don’t make much income so I can’t really work less. We’ll try to find some ways to reduce our income next year. Thanks for the input.

  • peter April 14, 2014, 11:39 am

    This to me would be a nightmare.
    Such an Asian thing this real-estate business is; ok popular in the UK too where it’s called “property”.
    Time was when a spot in the line for off-plan buyers was exchanged for $3,900 in the late 90s in Hong Kong, but the 14 years from the 1997 peak to the trough to the peak again in 2010 killed speculators. The Hong Kong government then hammered the nail in this coffin with a special stamp duty for non-residents (target, hot-moneyed mainland Chinese) and an extra special one for flippers. I’m surprised that we continue to remain the world’s freest economy (since 1994) despite this intervention by a less-liberal-by-the-day government.
    When I live in the States, I rent and invariably the landlady has been Asian (Taiwanese these days in the north-east). This poor soul and her husband work 3 jobs between them to pay off the mortgages on their home and rentals. I’m not really helping because when I did the math (including a 50% appreciation of the rental over a decade, 4% and change in mortgage rate, 30% down-payment and whatever wiggle one gets in Uncle Sam’s mortgage deduction), it is far better to rent and be invested the Dogs of the Dow or the SPY.
    I simply cannot see why anyone what want the life of a landlord, unless you enjoy wearing a vest, packing heat and cleaning out a ghetto.

  • Grisell Plasencia April 14, 2014, 12:51 pm

    I enjoy your blog!

    I owned investment property since 1993 and had never sold any due to the same problem, taxes! I retired at Age 45 four years ago, and it is a lot easier to managed. My plans are to keep them and hopefully leave them as an inheritance.
    I like the fact that I do not have to touch my stock portfolio, 401k, mutual funds, etc.
    Do what make you happy.

  • Nextbiteoflife April 14, 2014, 12:51 pm

    Invest $1000 or 2 and hire yourself a very good accountant, no..a great accountant. This is no job for Turbotax. You might still take a hit, but it might be money well spent. I never regret spending it yearly.

  • insourcelife April 14, 2014, 2:14 pm

    While it sounds depressing to think that you will owe that much in taxes if you sell, it’s really a great situation to be in. When it’s time to sell our rental condo we plan on moving in for 2 years to avoid paying taxes on appreciation. It’s really not a problem since the condo is in the same general area as our current house so not much would change, besides 3 less bathrooms to clean!

    • retirebyforty April 15, 2014, 9:16 pm

      It’s only prorated so you still have to pay 60% of the gain if you live there for 2 years. I updated the article a bit.

  • Brent @ All About Interest April 14, 2014, 3:06 pm

    I suppose this is a good problem to have. It it were me, I’d probably get a property management company and keep the rental since you don’t like dealing with a lot of the hassles of managing a property on your own. So far I’ve had good luck with tenants but I’ve only been a landlord for a few years now. I’ve also not had to use a property management company yet.

  • 1stuhave2findthetunnelb4ucthelight April 14, 2014, 4:18 pm

    I’d suggest you consider a compromise.

    1) Logically, it makes no sense to do a 1031 exchange if you are looking to exit the rental / landlord business. So personally, if you’ve trying to simplify your life, I’d take that off the table. Moving into that rental house, full/part time also makes no sense when it comes to quality of life. Mrs RB40 is your “sugar momma” for stable income/insurance, and if she’s happy with her work now, a 2 hr commute will quickly change that level of happiness (by the way, you previously mention she was looking for another job? but was happy with her work?).

    2) It seems odd to host an early retirement blog without having some diversification into a rental property. It should be a part of “passive” income for the vast majority of people trying to retire “early”.

    3) I’d say go ahead and sell your 4-plex. No matter how you look at it (property manager or not) it’s still 4 renters that have to be dealt with. Liablity risks are 4x higher than single rental property (i.e SFR). When real estate is “hot” people will buy anything, especially thinking there going to make it rich on rental income (probably not true). A home, in my opinion, will still be a more long term sought after item for families that feel owning is better than renting in the long term. Probably did my math wrong, but sounds like there would be, after everything, $120,000 net cash in pocket or so if you sold the 4 plex. The mortgage on that property is high enough to be a concern if you had trouble on rental income.

    4) Take those funds and pay off your $70K mortgage owed on the rental home. Owning a paid off rental property is great long term security/diversification. Now you free up some month to month income on this property which is important given your relatively low income. Fully paying off a mortgage is different than simply paying additional priniciple (and still having the monthly morgtage).

    5) Yes, your wife wanted to be “free” of being landlord, but this is the time to compromise. Make it more “turn-key” which now that all rent would essentially be net income (minus taxes/insurance/upkeep, other fees). Not sure the rent, but assume could generate $1k net income per month with all expenses. Make changes to property management, hire property manager, pay for lawn care, pay for very regular maintenance so that it is now “turn-key”. Increase your umbrella liabiity with the extra cash flow. I’d even argue (as I use) very detailed leases spelling out things like no backyard/yard structures can be built (vs the standard type leases which don’t go into more details), and go to lease that turns month to month. (Why month to month? So long as renters keep place up/pay rent then better to give YOURSELF the option of getting out a lease in 30 days for no resason required than big eviction issue on a standard lease). For a great renter, reward them with keeping rent rate same. Have your property manager contract require quick monthly walk through to continue the lease so you’ll catch things that you don’t want like a treehouse. Put in a warning about the creek in back that has to be signed (Really no different than renting a home with a risk such as a pool). Have them work on better background checks/references for renters, as it’s awesome when you’re happy with renter and renter is happy with your property and wants to stay long term. Even provide “great rent rate” in exchange for great renter. Without having the monthly mortgage expense, you won’t feel so worried if it didn’t get rented immediately and took a little longer to find an outstanding tenant. Give this compromise a try for say 2 yrs and then re-evaluate.

    6) Will real estate go flat? Will it go negative? Will it increase? Should you sell now vs. later? Will you kick yourself for selling? Kick yourself for not selling? Same questions about the stock market (which sounds all rosey right now and how quickly we forget). It simplifies your life to pay off your other rental. Less stress if your couldn’t get rented for a couple of months. More security if wife lost her job or had lowered income (i.e had some health issue, etc that you can never predict).

    7) Having rental income may help pay for your son’s college. Having a 2nd fully paid home within 1 hr of your home, may provide a more reasonable option if you had to
    put the in-laws reasonable near you, without having to buy a bigger primary residence in a “seller’s” market which really only makes you psychologically feel better about the
    new residence you’re want to buy which as at a premium (aka “sellers market”). Sure they are not living in your house, but a reasonable compromise in life to be 1 hr away.

    8) My parents, unfortunately, didn’t have any huge stock market gains/profits. They were able to stay in their hugely appreciated primary residence in a very affluent area with primarily social security and a fully paid rental property providing the nice “disposable” income/quality of life. Seems odd you’d want to remove a rental property from your retirement plan, in my view.

    9) Ultimate security. If something unforseen happened (health/otherwise) and it became necessary to sell your primary residence, you can sell that tax free (essentially) and then move back into your “rental” property. At that time, your wife may not be
    working at her current job and/or may want to retire. While you prefer your current primary residence, doesn’t sound like your rental home is an that horrible of a location that you wouldn’t consider living if you had to move back. This would be a way to defer the depreciation payback also.

    I bet 15 yrs from now, you’ll be saying how nice it is to have a fully paid rental that has continued to appreicate that you could sell if you really needed for financial reasons.

    • Mrs. RB40 April 15, 2014, 8:28 pm

      I should probably explain my statement regarding “being happy with my job and looking for a job simultaneously.” I like my job very much as I fill a rather unique niche in my field. However, I always “job hunt” so I can remain abreast of current skills needed since I like to learn. And for those who are job hunting, it’s best to look for a job when you’re happy in your current job. Sounds like a strange paradox, but it is true (because it means you’re not at the desperation point).

    • retirebyforty April 15, 2014, 9:22 pm

      Thanks for your extensive reply. I put the 4-plex on the market so we’ll see how that goes. Actually, it’s pending inspection and I hope everything goes through okay. It does make a lot financial sense to keep the rental home. We’ll see how it goes. I guess we’re not thinking logically right now. My mom couldn’t live in the rental home. She doesn’t drive and it’s in the suburb.
      I’d rather get a small 3 bed/2 bath in our current area. I know it’s not the smartest move, but life will be much more comfortable with that option. I’ll think about keeping the rental home more.

  • Done by Forty April 15, 2014, 7:29 am

    If you can stomach the process, I do think a 1031 is the best route since avoiding that taxation is like a guaranteed return on your money. Unless you guys might have a down year in income coming up relatively soon (in which the tax hit might be smaller and more palatable), I’d consider going that route and seeing if a property manager might ease the stress of being a landlord.

    • retirebyforty April 15, 2014, 9:23 pm

      Yeah, I’ll try the 1031 exchange and see how it goes.

  • FI Fighter April 15, 2014, 8:25 am

    Hey Joe,

    I’m looking at doing a 1031 exchange as well into more rental properties. Like you mentioned, for the tax and depreciation deferment. Not sure if you’ve considered turnkey investments, but that’s a way to keep investing in rentals and to be more hands off. Yes, you’ll still have to keep tabs on your PM, but it should be pretty low stress if you can find the right company to work with. Initially I was thinking about doing a 1031 into an apartment building, but I’m not sure if I want to deal with that headache just yet…

    • retirebyforty April 15, 2014, 9:24 pm

      Good luck with the next property. If the 1031 exchange work out, we’ll work with a property manager. I just don’t have time to deal with renters right now.

  • steve April 15, 2014, 3:19 pm

    There are a couple of other options for 1031 exchanges that don’t require you to be an active landlord. I haven’t done either of these, but you might want to check them out:

    Tenant-In-Common securities offerings are available to 1031 Exchange investors who seek a” hands off” investment while still taking advantage of the benefits associated with owning real estate. A Tenant-In-Common structure is one where multiple investors, with a maximum of 35, hold an undivided fractional interest in a property. Each investor holds title to the property for their portion of ownership. Typically these offerings consist of institutional grade real estate such as apartments, office buildings, retail centers etc as well as oil and gas royalties. The property is usually managed by one of the owners or a 3rd party. NOTE: This is not a limited partnership structure.

    Energy Properties
    You may not be aware that investment property may also be exchanged into existing energy (oil, gas or coal) properties.
    This is not to be confused with oil and gas drilling programs which are not eligible for a 1031 Exchange but rather existing properties that are currently producing product.

    • retirebyforty April 15, 2014, 9:26 pm

      I have no idea about the energy properties. I’ll do a bit more research. How would you find those energy properties? Not much of that around here.

      • steve April 16, 2014, 9:16 pm

        Check out 1031energy.com

        I haven’t done this, but it should give you a good intro.

  • Mom @ Three is Plenty April 16, 2014, 7:32 am

    Make sure that you’re figuring your cost basis correctly. When I sold my rental, my accountant had me add in *every* improvement I made to the house (major or minor). Added landscaping? Adds to the cost basis. Replaced windows? Replaced fence? There are some grey areas with maintenance vs repair, but he “got” me an extra 5k back in taxes when we sold the house. If you can reasonably add it to the cost basis, do so!

    • retirebyforty April 18, 2014, 9:23 am

      OK, thanks. I’ll get an accountant next year. We’ll need it. We didn’t do much improvement at all. Just repairs. Maybe the deck at the old house. I don’t think I have the receipt for that, though. It was put in many years ago.

  • BlakeC April 16, 2014, 10:05 am

    Have you considered owner financing them? This can slow down your capital gain by taking it over years instead of in a bulk. This can be easier to do with the multifamily because there tends to be lots of investors looking to get creative financing. You could potentially get a decent amount down, and earn a good passive income through the interest.

    Another route is why not just hire a good property manager, and not worry about toilets? You still have to manage something (well actually someone), but it least it doesn’t require driving hours to the property and dealing with toilets. It would lower your return and your hassle, but might still have a better return that other routes.

  • mary w April 18, 2014, 12:37 pm

    I’m not sure why your increased taxes are so high. I think capital gains are taxed at only 15% (maybe 20% at higher incomes) but you’re showing a much higher rate. You said minimal depreciation recapture so that can’t be it.

    Is it because you lose other deductions with your high income for the year? If that’s the case then maybe sell one this year and one next year if that would help. This would be a situation where you should spend several hundred dollars to talk to a CPA so you understand UPFRONT what you might be able to do with you taxes in this unusual year. CPA can answer questions like: Better to do both in same tax year or spread out? Push some deduction to the next year (when income is back to normal)? Accelerate other deductions for when they are more valuable?

    All that said, since you are unhappy as a landlord you should sell the properties.

    • retirebyforty April 18, 2014, 10:25 pm

      Part of it is because we are not paying much tax at all this year. Our taxable income were under the 15% bracket and we were able to take advantage of many of the credits and deductions. I’ll talk to a CPA. Thanks for your suggestions.

  • Peony April 19, 2014, 4:40 am

    Yes, rental property can be a costly investment to get out of.

    1styouhavetofindthetunnel gave a really good response, IMO, with the suggestion that you downsize to one paid-off rental property from two mortgaged ones. I am able to live comfortably (modestly) off of two properties (5 units total), both of which I own free and clear. Owning outright has made a huge difference in the enjoyment level of landlording. It is still stressful when things go wrong but at least if I have to fix something major I am not also worrying about how I am going to make the mortgage payment.

    I have had many conversations about an exit strategy with my CPA and he has always advised just paying the taxes. Based on his estimates of cap gains/depreciation recapture, plus the normal transaction costs for real estate (broker fees, etc.), when I’m doing back-of-envelope figuring as to how much I will keep after a sale, I always calculate that I will receive 66% of what I sell the property for. I hope that is a worst-case estimate. The fact is I’ve had an amazing run with this investment, I’m enjoying the benefits of good cash flow and diversification (vs. my securities portfolio) and have been for a dozen years, and if the market holds up I’ll also get out with a chunk of cash.

  • Peter May 16, 2014, 11:09 pm

    First off, on the capital gain about 75K of it will be taxed at 25%, and the next 78K at 28%, so only a few K will be at 33%, All of course because you get pushed into higher brackets.
    How about selling them 1 at a time spread over 2 years, that way you will pay the least amount of tax.

    • retirebyforty May 19, 2014, 9:50 am

      If one doesn’t sell right away, then we’ll probably wait until next year to spread it out. Or we’ll try to do a 1031 exchange. We’ll see how it goes.

  • Antonio May 17, 2014, 2:48 pm

    I know that the IRS handles the taxes in 2 ways: short-term gain and long-term gain.
    It looks to me that your point of view is based in short-term gain, where you have to deal with your tax bracket.
    But, If you own that property by more than one year, it is a long-term gain business. So, you will pay 15% on tax when you sell it.
    Please, let me know whether I am wrong on it….

    • retirebyforty May 19, 2014, 9:53 am

      I’m not a tax expert so I could be wrong about this. The profit is long term gain, but it still pushes my income up. That mean I’ll be ineligible for many deductible and write offs that I could take advantage of if I didn’t have a big long term gain. The tax is still 15%, but the loss of various deductions add up.

  • Levi March 23, 2015, 9:32 pm

    one thing a lot of people don’t realize, is when you do a 1031 exchange AND have an existing mortgage, you need to pay 20% capital gains tax on the balance. crazy I know, but this is how they get you to “take on equal or more” debt. It’s called Mortgage Boot. I am in a situation right now, selling a building that has gone up in value $2,000,000. my wife and I want to simplify, pay the tax and move on. (no more landlording!) after the sale, we will buy a new property for $800,000. we were told that with the $2M gain, the 1031 is actually MORE expensive for us and should be avoided. our mortgage balance happens to be $800,000 which means we would have to pay or reinvest an additional $160,000! dang…. there’s no real benefit to 1031 exchanging into this 800k property. if anyone else has heard of this I’d love to hear from you.

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