Best move regarding my rental property

[phonzie]

I own a rental property that isn't making any money. My AGI is too high to be able to deduct the losses I'm incurring from it. Any ideas on what I should do?

The property is a townhouse, and was purchased new in 2004. Cost was ~$150K. I lived in it until 2008. I tried to sell it, but best offer was $120K so I kept the property and started renting it out. I hired a property manager.
In 2010, I earned $10700 in rent. My costs were: mortgage interest $6400, depreciation $4400, association fee $1300, property tax $1900, property manager fee $750, liability insurance $160, other misc costs such as repairs, maintenance, etc $190. My overall costs were $15100, so I lost $4400 on this rental property in 2010. My losses in 2008 and 2009 totaled $7400.
I currently owe ~$107K on the mortgage. The mortgage interest rate is 5.875%
My AGI in 2010 was ~230K and will likely stay the same or slightly increase in years to come. I'm single, have no kids, and I do not own any other property.

Should I sell the rental property? I'm not sure what I could sell it for in this market, but I'm guessing it could fetch at least $120K. How would the depreciation and the sell price affect my taxes after I sell the property?

OR, should I pay off the mortgage, and start earning income on the property? I have enough cash to pay off the entire mortgage right now. Paying off the mortgage would result in about $2K income per year from the rental property. Can I deduct previous years' losses against this income?

OR, should I just continue as is, losing money on the property every year? Is there any advantage to this?

Another question:
I stated on my 2008, 2009, and 2010 tax returns that I did not actively manage the property, so I did not deduct any of the rental property losses off my personal income. Had I stated that I was actively managing, in 2008 and 2009 I could have deducted some or all of the losses off my personal income. My 2008 AGI was $52K, and in 2009 it was $110K. In 2010 my AGI was too high to matter if I was actively managing the property or not. I'm not sure what it means to be actively involved or not. I now live in a different part of the country than where my rental property is. I approve the rental rate, the tenant, and any major expenses. I pay the mortgage, association fee, property tax, and liability insurance. Otherwise my property manager takes care of the rest. Am I actually actively involved in the property management? Should I amend my previous tax returns to get some money back? My job is in health care, not related to real estate at all.

Thank you so much for any input! I really appreciate the advice and knowledge from this forum.

[bjl584]

Can you do a refi?

A lot of the books that I've read concerning real estate investing suggest keeping the property financed and refinancing every so often to lower expenses and increase cash flow.

I'm not an expert, but that seems like it could be a logical fix to your problem since you aren't able/willing to sell at a loss.

[JoshuaHeckathorn]

I'm in a similar situation with a rental property, and I've decided to hold onto it and continue paying down the mortgage as much as possible. Remember, when you do sell in the future (hopefully for a profit), all those passive losses you've build up offset the gain on the property and will lower the capital gains tax you'll pay. You don't get to deduct them now, but you will someday.

I'm not a CPA, but I've spent a great deal of time chatting with my CPA about passive vs. ordinary income/losses. The IRS rules are very strict regarding whether you can consider yourself a real estate professional and offset ordinary income (from your healthcare job) with real estate losses. Based upon what you've told us, I don't think it sounds like you could consider yourself a real estate professional actively managing your property. I find myself in the same boat.

[krantcents]

Now is a great time to refinance the property. In addition, I would try to increase the rent. Check the market of similar properties and see if you can increase the rent. The goal is to have the property break even as soon as possible. In this way, you can hold on.

[phonzie]

I refinanced at the end of 2009. Rates back then were around 4.8%, but the bank added an extra percent because it was an investment property. Since then rates have come down even more, and maybe if I shopped around more, I could get a better investment property rate. I will consider refinancing again, but there are always refi costs (not only dollar amounts, but significant amounts of my personal time).

Joshua, I bought the property at the height of the bubble in this town, and I'm worried that the property will never raise in value enough to offset the losses I've accumulated on it. I'm wondering if I should cut my losses now instead of hoping the value will increase.

[maat55]

I suggest you ask this question at this site below. I have frequented it on many occasions and find the site helpful.

Real Estate Investing Forums | BiggerPockets.com

[jpg7n16]

Originally Posted by phonzie

In 2010, I earned $10700 in rent. My costs were: mortgage interest $6400, depreciation $4400, association fee $1300, property tax $1900, property manager fee $750, liability insurance $160, other misc costs such as repairs, maintenance, etc $190. My overall costs were $15100, so I lost $4400 on this rental property in 2010. My losses in 2008 and 2009 totaled $7400.
I currently owe ~$107K on the mortgage. The mortgage interest rate is 5.875%

If you look at your loss compared to expenses - it's actually only a paper loss. Total loss = $4400; amount of depreciation = $4400.

If you want to keep the house, I would either keep hunting for better refi offers, or pay down/off the mortgage.

This would reduce the amount of interest expense, and help you show a profit - and a positive cashflow.


You should then also speak with your CPA to determine if you could then begin harvesting the previous years' disallowed losses that have been carried forward against that income.


If you sold the home, you may be able to deduct the value of the carried forward disallowed loss. (Speak to a CPA and see Publication 925 (2010), Passive Activity and At-Risk Rules for more details)

From: Publication 925 (2010), Passive Activity and At-Risk Rules

Dispositions

Any passive activity losses (but not credits) that have not been allowed (including current year losses) generally are allowed in full in the tax year you dispose of your entire interest in the passive (or former passive) activity. However, for the losses to be allowed, you must dispose of your entire interest in the activity in a transaction in which all realized gain or loss is recognized. Also, the person acquiring the interest from you must not be related to you.

[JoshuaHeckathorn]

Originally Posted by phonzie

I refinanced at the end of 2009. Rates back then were around 4.8%, but the bank added an extra percent because it was an investment property. Since then rates have come down even more, and maybe if I shopped around more, I could get a better investment property rate. I will consider refinancing again, but there are always refi costs (not only dollar amounts, but significant amounts of my personal time).

Joshua, I bought the property at the height of the bubble in this town, and I'm worried that the property will never raise in value enough to offset the losses I've accumulated on it. I'm wondering if I should cut my losses now instead of hoping the value will increase.

Was 2004 really the height of the bubble where you live? It didn't hit most places until 2007 to early 2008, so you should be in a better position than some. Anyway, I know what you mean about worrying if the value will ever return- I'm in the exact same position with a rental I bought in 2004. It's a tough call in this market, because it's very possible you're just throwing good money at bad money. I'm still optimistic though...at least for now.

[phonzie]

Maat, thank you for the link. I just posted my questions there.

Jpg7n16, thanks for the advice. My CPA (who I've only used once), wasn't very helpful with these questions last time I spoke with him. I will contact him again, and if he is not helpful again, I will find a new CPA.

Joshua, you're right, I think the actually bubble was around 2006-7 in this town. By the time I wanted to sell in 2008, the market had deflated.

[jpg7n16]

Maybe these links can help:

Find a CPA/PFS Near You

Or do a Google search for: CPA CFP (your state)

[krantcents]

The market is still soft, you may end up losing more than you think. If you want to just take the hit and not look ack, I would check with a realitor. You won't be able to sell in the first weekend. It will take time. It is still a buyer's market. Also you should examine your situation with a CPA.

[phonzie]

Consulting with a CPA/PFS sounds great. I will pursue that next.

[mcfroggin]

You shouldn't count depreciation in deciding whether to keep the property right now. The housing market is way down. Only use depreciation when talking to the IRS.

Your loss was only $400. Refinancing could turn this into a profit.

Do you not know anyone in this city that could "manage" the property for you at a lower price?
Depending on the property and rentor, managing one property may not be difficult at all for someone to do. If you "managed" the property by "outsourcing" jobs to friends, I don't see why you couldn't take a tax deduction on it.

In this down housing market, you might consider buying a few more rental properties in that area. You could "manage" the properties through a "home business" and take huge home business tax deductions. This is assuming you don't already take these deductions.

These are just some of the possibilities that you should consider. Verify everything with a CPA - my post is merely educational.