The property is a condo in another city (about 4 hours drive) and I have a property manager that charges 12%. The tenants are the best I could hope for (no problems in approximately two years). I net about $200 a month after expenses.
I know there are relative advantages to selling and investing the equity elsewhere, but that's not my question. My question is: What are the tax advantages of holding onto it? I'm thinking not much. For instance, being able to deduct HOA fees, taxes, insurance, PM fees, etc. is not that attractive, as I see it, if they are canceled out by having to pay taxes on the rental income.
So the only other "advantage" is depreciation, which isn't an advantage at all in the long term because it has to be paid back upon sale (and I am planning to sell the property at some point in my lifetime). Even appreciation isn't much of an issue as this is a very modest condo and values are increasing very slowly. And of course any net profit has to be offset by commissions, closing costs, etc.
So what do all the landlords and former landlords out there think? I used to pay an accountant to do my taxes, and I asked him this question, but he couldn't, or didn't want to answer (given my experience with customer (non)service throughout my life, I wasn't surprised, but that's another story - but it is one reason I turn to informative forums like these). Thanks.
P.S. I anticipate that someone will suggest dropping the property manager. I realize that's an option, but let's assume it's not and focus on other fiscal fiscal advantages, if any, of continuing to own and be a landlord.
By owning the building and using it as a rental you have four main issues to think about.
First, what is your present return on investment. For example, if the building is worth $100,000 and your net profit before taxes is $1000 a month, then your ROI is 1% per month or 12% per year. That's about the same as you could do in the stock market today, but the stock market is unlikely to be that good over The long run. Average S&P 500 return is about 8% per year.
Second, in addition to your present rate of return from the rental income, there is the possibility that the building will appreciate and gain in value. Although that gain is taxable when you sell, so would the gain from any other investment.
Third, you will have to deal with the issue of depreciation recapture. When you sell the building, depreciation is recaptured at 25%, and the rest of your gain, if any, is taxed as a long-term capital gain at 15%.
Fourth, if you own the building until you die, and pass it onto your heirs, your heirs will inherit a stepped up cost basis and will not have to pay capital gains tax or recapture depreciation when they sell. They will get the entire value of the building as an inherited asset.
So the value of continued ownership is the present return on investment, plus property appreciation if it appreciates, minus the taxes you will owe when you sell it. You might want to reduce your estimation of the value of holding the property by an amount to compensate for the hassle and uncertainty of renting to tenants.
Against those factors, you have to think about where you would invest the money, how much risk you can tolerate, and what rate of return you would get if you sold the property. .
So if I have $800 in expenses, I can tack on an additional profit of $160 to my monthly net income. And this benefit wouldn't be common knowledge to the casual observer. I'm wondering if there are other such advantages I'm not aware of.
I didn't know, Opus, my heirs would not have to pay capital gains or recapture depreciation. That's good to know, but as I said, I plan to sell at some point in my lifetime.
What is the 25% of depreciation recapture? Does that mean if I got deductions amounting to $10,000 for depreciation for the whole time I owned the property, I would only have to pay back $2,500? I thought we have to pay back the full $10,000 - no?
My ROI is less than the S&P average, but I'm thinking it could get closer if there are other advantages.