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The home was bought in Dec. 2010, and we lived there from Dec. 2010 to Jan. 2013. It's been a rental property since Feb. 2013, when we moved into a rental home to be closer to work (about 30 miles away from the original home).

After almost a year at the current (rented) place, we've pretty much settled that we'll not return to the previous location (son started kinder @ the new place). Selling the old home will most likely not get us into owning a new home at the new location, so the thinking is whether we sell or continue to rent out, we would stay that way through the next five years.

Currently, we are renting the home out at 2.2K while renting the home at 2.1K.

We were in the 15% tax bracket w/ home related deductions in 2012. We'll probably stay in the same bracket this year w/ the (dismal) rental income but land in the 25% bracket after selling the home (doing w/out the deductions). The home has increased about 15% in three years (unrealized, of course).

I am leaning toward selling because I'm not sure 1) if the home value will continue to rise, 2) what amount of capital gains tax will I face if it does rise (vs. selling now), and 3) the risk of vacancy (we can't afford 2+ months of vacancy).

I am also not sure how to weight the benefits of continuing to rent out for five years in terms of, 1) taxes saved and 2) increasing home value (treating it as investment).

Any help or point of view are greatly appreciated.

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You need to get the current tax software, the 2013 filing software is out already, even though it needs to update itself before filing, as the final forms aren't ready yet.

Then you will look carefully at Schedule E to understand what gets written off. I see you are looking at the $2200 rent vs your own rent of $2100, but of course, the tax form doesn't care about your rent. You offset the expenses of that house against the income.

The expenses are the usual suspects, mortgage interest, property tax, repairs, etc. But there's one big thing new landlords are prone to forgetting. Depreciation. It's not optional. Say the house cost you $400K. This is your basis. You need to separate the value of land which is not depreciated. For a condo with no land it can be as little as 10%, when we bought our house, for insurance purposes, the land was nearly 40% of the full value. Say you do the research and decide 30% (for land), then 70% = $280K. Depreciation is taken each year over a 27.5 year period, or just over $10,000 per year. (Note, the forms will help you get your year 1 number, as you didn't have a full year.)

This depreciation helps with your cash flow during the year (as you should do the math, and if you keep the house, adjust your W4 withholdings for 2014, that lump sum you'll get in April won't pay the bills each month) but is 'recaptured' on sale.

At some point in the future, you may save enough to buy a house where you wish to live, but need to sell the rental. Consider a 1031 Exchange. It's a way to sell a rental and buy a new one without triggering a taxable event. What I don't know is how long the new house must be a rental before the IRS would then allow you to move in. The same way you turned your home into a rental, a rental can be turned back to a primary residence. I just doubt you can do it right after the purchase. As fellow member @littleadv would advise, "get professional advice." And he's right. I've just offered what you might consider. The first year tax return with that Schedule E is the toughest as it's brand new. The next year is simple in comparison.

The question of selling immediately is tough. Only you can decide whether the risk of keeping it is too great. You're saying you don't have the money to cover two month's vacancy. That scares me. I'd focus on beefing up the emergency account. And securing a credit line. You mentioned the tax savings. My opinion is that for any investment,the tax tail should never wag the investing dog. Buy or sell a stock based on the stock, not the potential tax bill for the sale. In your situation, the rent and expenses will cancel each other, and the depreciation is a short term loan, from a tax perspective.

If you sold today, what do you net? If you analyzed the numbers now, what is your true income from the property each year? Is that return worth it? A good property will provide cash flow, principal reduction each year, and normal increase in value. This takes a bit of careful looking at the numbers. You might feel you're just breaking even, but if the principal is $12K less after a year, that's something you shouldn't ignore. On the other hand, an exact 'break-even' with little equity at stake offered you a leveraged property where any gains are a magnified percentage of what you have at risk.

Last - welcome to Money.SE - consider adding some more details to your profile.

  • Thank you for this very thorough response. Professional advice/service will definitely be used for my '13 filing. I do get the depreciation part, which is also the most concerning part for me as the value depreciate now equals increase in cap. gains tax later. – nutella Dec 26 '13 at 16:41
  • @nutella - re:depreciation - exactly. It helps with the flow today, but costs you down the road. Read up on 1031 exchange, that may be ideal for you in 5 years. – JoeTaxpayer Dec 26 '13 at 21:00
  • Quick note, as I was reading about 1031, I realized I can sell the home as primary residence (avoid tax) if it was occupied two years out of five. I thought it's three out of five for some reason. As we've lived there during the first two years and have rented out for one so far, this gives us about 1.5 - 2 yrs to gather our next move. Thanks again! – nutella Dec 27 '13 at 4:09

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