By Benny L. Kass
Saturday, December 1, 2007
Q: I have rented a single-family house to the same tenant for 15 years. The tenant is moving out next month.
I owe $68,000 on the property, and it could sell for $280,000. It probably needs $25,000 in improvements to bring in that much.
I am a novice investor. However, I would like to eventually own an investment that gives me enough cash flow that I could go into partial retirement. This property nets $200 per month. I am trying to figure out if I should do a 1031 exchange and get a four- or five-unit apartment building (which would cost $400,000 to $500,000) or a commercial building. I do not know a lot about commercial property.
I could also fix up my house and rent it out again, or just sell it. If you were in my shoes, what would you do? -- Eric
A: DEAR ERIC: Not everyone can fit in the same shoes, so you have to decide what's best for you. Do you want to continue to be a landlord? Will your rental continue to appreciate in value, or is the neighborhood stagnant? If you decide to get a multi-unit building or a commercial property, will you be able to manage it, or will you have to hire professionals? Even if you go into partial retirement, will you have enough time to deal with the problems of rental properties?
Some people simply decide to sell their investment real estate, pay the capital gains tax and pocket the rest of the sales proceeds.
If you are comfortable with continuing as a landlord, I suggest that you discuss these issues with your financial advisers. Have them run the numbers on the various options, which include keeping your rental property, selling it outright and doing a 1031 exchange. Such an exchange allows you to defer capital gains tax by selling one investment property and obtaining another, following rules set by the Internal Revenue Service.
You should get all of the financial reports on the properties you are looking at. You will want to review the income and expense statements for at least the past three years. Keep in mind that just because that landlord may be making a profit does not necessarily mean you will. You will need to obtain a larger mortgage, which means your monthly debt service will be higher. You should also have a professional engineer inspect the property; for all you know, the landlord has deferred a lot of maintenance, which would mean that you will have to spend a lot of money to bring the property up to par.
You should also review the existing leases. Are the rent levels acceptable? Are you locked into long-term leases with low-rent tenants? Are there any delinquencies?
And finally, your lawyer should advise you on the local landlord-tenant laws. In some jurisdictions, such as in the District, the laws (and the courts) are heavily weighted in favor of tenants.
You say you are a novice. This does not mean you should shy away from investments. What it does mean, however, is that you must have competent professionals advising you. While real estate agents will be helpful, keep in mind that they want to sell you properties so they can make a commission. Your advisers must be independent.
I keep hearing that private mortgage insurance can now be deducted on your federal taxes, but certain dates and time frames must be met. I got my mortgage in January 2005. Can I use the PMI deduction? -- Wesley
DEAR WESLEY: You will not be able to take the deduction because you don't meet the time frames.
PMI, which is required on many loans with a down payment of less than 20 percent, protects a lender if the borrower goes into default. For years, tax lawyers have argued that PMI is like mortgage interest and should be deductible for tax purposes. However, the IRS was opposed. Eventually, Congress stepped in and passed a law allowing homeowners to deduct these premiums.
But there's a catch. This deduction is allowed only for mortgages obtained in 2007.
You should, however, talk with your lender or lawyer about the law that allows homeowners to cancel private mortgage insurance when the equity reaches a certain level.
My wife and I own a lot in a retirement community, primarily as an investment. There is little chance that we will ever build on it. I pay community maintenance fees of $600 a year on the lot, as well as a water availability fee of $10 a month. Considering that the lot is held primarily as an investment, are these fees deductible for tax purposes? -- Roger
DEAR ROGER: Generally, if the lot is held for investment purposes, you should be able to deduct all reasonable expenses associated with it, including community association fees, utility bills and real estate taxes. You will not be able to take any depreciation because it is raw land.
Tax questions can be answered only generally because everyone has different financial issues. You should talk with an accountant for a specific answer.
I want to buy a home in Nevada and rent it to my sister and another tenant until I retire, in 10 years. If one of the tenants will be a relative, will the IRS consider this a legitimate rental property with rental property deductions, as long as I have a lease and can provide proof of monthly rent? Also, is there any reason why the IRS needs to know that one of my tenants is a relative? -- Bonnie
DEAR BONNIE: As long as your lease is at "arm's length" and the rent you charge is consistent with market rentals in the neighborhood, you should be able to take all the legitimate deductions available to landlords. The forms you have to fill out when you file your annual income tax return do not ask for names or family status; the IRS just wants to see the numbers.
You should consult with at least two real estate agents and get them to provide you with rental comparables. Keep that information handy in case you are audited.
I found a buyer for my home and think we can come to agreeable terms. Is it cheaper to just hire a lawyer rather than have a real estate agent do the transaction?
-- Katherine
DEAR KATHERINE: I have nothing against real estate agents and brokers. They perform a valuable service in most cases. However, if you have already found a buyer, you should consider retaining legal counsel, who can assist you in preparing the sales contract. The lawyer can also walk you through the entire process up through settlement.
An agent will charge 2 to 6 percent of the sales price. A lawyer will charge on an hourly basis. In my experience, it is usually much less expensive to retain legal counsel. More important, should problems arise, the real estate agent could not provide legal advice.
Whether or not there is a real estate agent in the picture, sellers should also have their lawyer involved in the process.
Benny L. Kass is a Washington lawyer. Questions for this column can be submitted tobenny@inman.com.
Copyright 2007 Benny L. Kass
Distributed by Inman News
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