Rentals...Worth the effort?

[LD1]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

Thats how rentals work, It dont make them a waste of time though, if you are aware what you are doing.

Over the (29 years IIRC) a rental depreciates to 0 value. Thus when you sell it, the entire amount is subjected to taxes. Which is why most reccomend to stay cash flow positive. So when you sell, you recoup your investment and not necessarily make a profit upon sale. Rather the profit was the positive part of the "cash flow positive" all along.

But even if you set it up to be neutral cash flow.....IE.....rent coming in pays all bills and mortgage and leaves none for your pocket......then when you sell, all the money it is sold for minus taxes is still profit. Since you incured no expenses that wasnt covered by the rent.

If you were cash flow negative.....thats on you and a bad investment.

Mine is $500 positive. So I put $500 a month in the bank. ($6k/yr). The annual depreciation over 29 years is like $6500. So even though I put $6k in the bank a year, on paper it shows I loose money. So I dont pay taxes, persay, for the first 29 years.

After 29 years, If I choose to sell, even if I sell for what I paid (187k), and take taxes out, its still a nice chunk of change that didnt really cost me anything.

If you are loosing money all along, then loose money on the sale, you are doing something wrong.

 

[teejk]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

Now wait a minute...did you sell it for more than you paid? Did you get annual deductions for depreciation at higher rates than capital gains rates when you sold? Rental real estate is only a "timing" thing. A dollar spent today still has to come back to a dollar when you sell it (even if that dollar got depreciated down between buy and sell...you will "recapture" those benefits on sale...if you did it right usually at lower rates). People tend to forget that...

 

[LD1]

The only way I see loosing money is if you are loosing money every month, then sell for less than you paid.

If its at least net zero where you aren't making or losing money every month, but just breaking even....then even if you sell it for a dollar, that's a dollar profit....since purchase price is irrelevant.... As rent money paid the mortgage and not the money in your pocket

 

[ultrarunner]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

Here people will 1031 exchange until they die and the estate gets a stepped up basis.

Another approach is for the husband and wife to convert the rental to their primary home for 3 of the last 5 years last I checked and then up to 500k in profit doesn't count.

You are correct in that simply selling to get out carries recapture and many are caught off guard.

I know a Realtor that lives his life around this... he took his 4 unit building that he owned for a long time and exchanged it for a new luxury home... rented the home for a couple of years and then moved in as his primary... the way it was structured taxes were no longer an issue...

It does take planning and you need to execute...

 

[PILOON]

Guess I have been lucky.

We have rent control board that is very slanted for the tenants.
Seasonal rents are not covered by the board but short term (under 30 days) considered hotel and taxable as such.

I always got a 'caution deposit' up front and full rent prepaid.

I had 2 waterfront properties that I rented 'by the season', getting 5 ea summer and winter month blocks.
Summer renting was easier being lakefront but winter also not bad with choice of ski hills within 15 min drive plus virgin snow trails for cross country and snowshoeing.
My lease was about 2 paragraphs long basically saying 'enjoy the use and not abuse and return as you found it upon arrival'
Also we were about 1 hr drive out of Montreal. (with a huge population base) So I could be choosy.

Majority of my tenants were long term repeats, one retired couple rented 8 years running another with teens renting 6 winters running.
Only twice did I have problems but deposit covered the damages or clean ups.
Often folks actually left premises so clean and tidy that I never even needed to dust!

In the 'off time between seasons' I did whatever maintenance and updates that was needed.
Yard care and snow removal I took care of.
Folks were advised that grass and flowers were considered to be 'country rustic' (meaning that weeding and mowing was minimal).
Each property had a row boat and a canoe plus a dock and I provided life jackets as well.

True, I took pride in my properties and perhaps that is what made it work.
Both properties have been sold, and both to the last tenants that have become good friends and totally integrated to our little community and contributing to all our activities.

On the other hand I always tried to be fair and responded to their concerns which generally were usually reasonable.

LOL, one claimed bed was too soft and wanted firmer mattress. My reply was too soft for you, too firm for the next, sorry but I don't have space to store dozens of mattresses, funny but when he purchased he never upgraded that mattress.

Had another who's car never started and I'd boost him every 2ng WE. Each time he'd bring me a bottle of scotch as a thank you.
Another enjoyed gardening and planted more than I had plus she weeded constantly.

 

[WoodChuckDad]

Had a rental house 23 years. Thought it would make a good retirement income. Most of the time had bad renters. The last 8 year had a good renter that wanted buy the house. I sold it to them then the suprise came. All the depreciations I had taken over the years had to be added back on the price of house. That made the capital gain high. The goverment took all my profit. Having the rental was a waste of time.

Rental is a business. I'm not trying to be mean, but you should have known that before selling. Really, if you did your own taxes, the whole depreciation thing should told you that you had to pay it back at sale. The one I just sold, I worked in as a 1033 exchange and avoided the repayment of depreciation. I do have some cap gains for the increase in value, but I saved quite a bit in the depreciation repay.

 

[LD1]

Even not knowing, I still dont understand how you can "loose" all your profit to taxes?

I dont know a single person that purchases a rental and structures it cash flow negative. If you are, its not a good investment if you have to tap into your personal funds just to break even every month.

Worst case is cash flow neutral. Meaning you arent saving any money.....but not loosing money either.

So the whole time you are paying the mortgage on the rental.....it isnt really "your" money paying for it. Rather the rental income. So at the end of the 10, 15, 30, or however many years you finance......even if you made ZERO profit along the way........if it didnt cost you any of your personal money, you are ahead of the game. And your "profit" is the equity.

Should you choose to sell, sure, uncle sam is gonna take1/3 of it or so.....but the 2/3 that you keep is pure profit.

Again, if the combination of purchase price, rental income, length of term on the mortgage, etc is such that you were LOOSING money and having to tap personal funds month over month......not a good investment. And I would certainly not have held onto it for very long.

 

[California]

Its been 30 years so likely the laws have changed, but when I sold my rentals I asked less than 29% down payment and carried the balance as a mortgage to me. This spread the tax on capital gain over several years instead of all due in the year of sale. Even so - the last, and largest sale was in a year when I was finishing my MBA and only my wife was employed. But that was the only year we have paid taxes in the 48% marginal rate bracket. And only seven years after a beat up Ford pickup constituted my total assets.

The most important thing I learned in grad school was the value of planning. As applied to rentals make a clear plan of where you will be at the end of the plan. Then focus on working toward that. As I learned more about finance I shifted to a more sophisticated goal, from simply operating rentals, to seeing the advantage of reselling properties that were now worth more due to my renovations - and then carrying the financing. My income from those notes over the next several years covered the payments on a nice home that is nicer than what our wage incomes could have supported in those early years.

Everybody's situation is different but work through different scenarios and see if there is potentially a better outcome if you re-state your goals. In this exercise you might discover a more direct path. And be sure to include taxes in your calculations!

Also - a hard look at where you might be in the future might help avoid a Detroit-type outcome. It's not that hard to see that a neighborhood is declining, and bailing out even at a loss might in some cases be the best way to preserve what you can. Blindly holding on would be unrealistic.

 

[California]

The Brits traditionally have a different perspective on wealth. Americans ask 'how much is he worth' and expect to hear net assets.

Brits ask this question and expect to hear how much passive - non work related - income the individual receives annually and perpetually.

Learning that new definition opened my eyes!

 

[teejk]

Its been 30 years so likely the laws have changed, but when I sold my rentals I asked less than 29% down payment and carried the balance as a mortgage to me. This spread the tax on capital gain over several years instead of all due in the year of sale. Even so - the last, and largest sale was in a year when I was finishing my MBA and only my wife was employed. But that was the only year we have paid taxes in the 48% marginal rate bracket. And only seven years after a beat up Ford pickup constituted my total assets.

The most important thing I learned in grad school was the value of planning. As applied to rentals make a clear plan of where you will be at the end of the plan. Then focus on working toward that. As I learned more about finance I shifted to a more sophisticated goal, from simply operating rentals, to seeing the advantage of reselling properties that were now worth more due to my renovations - and then carrying the financing. My income from those notes over the next several years covered the payments on a nice home that is nicer than what our wage incomes could have supported in those early years.

Everybody's situation is different but work through different scenarios and see if there is potentially a better outcome if you re-state your goals. In this exercise you might discover a more direct path. And be sure to include taxes in your calculations!

Also - a hard look at where you might be in the future might help avoid a Detroit-type outcome. It's not that hard to see that a neighborhood is declining, and bailing out even at a loss might in some cases be the best way to preserve what you can. Blindly holding on would be unrealistic.

Agree. Appreciation is no longer a given in many markets. The benefits of depreciation deductions made it work when interest rates were high (save a dollar today to pay it back 20 years from now made sense at one time IF people remembered that the dollar had to be repaid, which many of them didn't). In the right markets rentals would make sense though but I always advise people...there is no such thing as getting high returns at zero risk.