DEAR BENNY: I have rented a single-family house out to the same tenant for 15 years, and this person 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 in order to sell it (unless I decideto sell it as is). I am a novice investor. However, I would like to eventually own an investment that gives me enough net cash flow so that I can go into partial retirement. The property nets $200 per month. I am trying to figure out if I should do a 1031 exchange and obtaina four- orfive-unit building(which will cost between$400,000 and $500,000) or a commercial building. I do not know a lot about commercial property. I could also fixup my house and rent it out again, or just sell it.If you were in my shoes, what would you do? –Eric
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 current rental continue to appreciate in value or is that neighborhood stagnant? If you decide to get a multiunit building (or a commercial property) will you be able to manage it or will you have to hire professionals to assist you? Even if you go into partial retirement, will you have enough time to deal with the myriad of problems that rental properties create?
Only you can make this decision. Some people just decide to sell their investments, 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 all of these issues with your financial advisors. Have them run the numbers on the various options, which include keeping your current rental property, selling it outright, or doing a 1031 exchange.
You should also get all of the financial reports on the properties you are looking at. You’ll want to review the income and expense statements of the new property for at least the last three years. Keep in mind that just because that landlord may be making a profit does not necessarily mean that you will. You will need to obtain a larger mortgage, which means that your monthly debt service will be higher. You’ll also want to have a professional engineer carefully inspect the property; for all you know, the landlord has deferred a lot of maintenance, which means that you will have to spend a lot of money to bring the property up to par.
You’ll also want to 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 attorney should advise you on the landlord-tenant laws in your state. In some jurisdictions — such as in the District of Columbia where I practice — the laws (and the courts) are heavily weighted in favor of tenants.
You state that you are a novice. This does not mean that you should shy away from investments. What it does mean, however, is that you must obtain the services of competent professionals who will be advising you. While real estate agents will be helpful, keep in mind that they want to sell you properties so that they can make a commission. Your advisors must be completely independent.
DEAR BENNY:I keep hearing that PMI can now be used as a deduction on your federal taxes. However, there are certain dates and time frames that must be met. I got my mortgage in January of 2005. Can I use thePMIdeduction? –Wesley
DEAR WESLEY: Unfortunately, you will not be able to take the deduction. PMI stands for private mortgage insurance. Lenders want security, and they usually are comfortable if you put down at least 20 percent when you buy a house. This way, should you go into default on your loan, and the lender has to foreclose (or take the house back by way of a deed in lieu of foreclosure) there will be sufficient equity so that the lender will not lose money. But if you put down less than 20 percent, lenders require that you buy private mortgage insurance. In the event of a default, the PMI company will pay the lender the amount of the insurance coverage.
For years, tax lawyers have argued that private mortgage insurance is like mortgage interest and should be deductible for tax purposes. However, the IRS was adamant in rejecting this position. Accordingly, Congress stepped in and enacted a law allowing homeowners to deduct their premiums.
But there’s a catch. This deduction is allowed only for mortgages obtained in 2007.
You should, however, talk with your lender or your attorney about the law that allows homeowners to cancel private mortgage insurance when the equity reaches a certain threshold.
DEAR BENNY:My wife andI own a lot in a retirement community primarily as an investment. Thereis very little chance that we will ever build on it. I pay community maintenance fees of $600 a year on this lot, as well as a water availability fee of $10 a month. Because this lot is held primarily as an investment, are these fees deductible for tax purposes? –Roger
DEAR ROGER: Tax questions can only be answered generally because everyone has different financial issues. Accordingly, you really should talk with an accountant for the specific answer.
Generally, however, if the lot is held for investment purposes, you should be able to deduct all reasonable expenses associated with that property, including the community association fees, any utility bill, as well as any real estate taxes that you have to pay. You will not be able to take any depreciation, because it is raw land.
DEAR BENNY:I want to buy a home in Nevada and rent it to my sister and one other tenant until I retire in 10 years.Because 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 provide the proof of monthly rent if necessary? Also, is there any reason the IRS needs to know that one of my tenants is a relative? –Bonnie
DEAR BONNIE: So long as your lease is “arms-length” and the rent that you charge is consistent with market rentals in the Nevada neighborhood, you should be able to take all of the legitimate deductions available to landlords. The various forms that you have to fill out when you file your annual income tax return do not ask for names or family status; the IRS wants to see the numbers only.
You should consult with at least two real estate agents and get them to provide you with rental comparables, and keep that information handy just in case you ever are audited.
DEAR BENNY:I have already found a buyer and believe we can come to agreeable terms.Is it cheaper to just hire an attorney rather than have a Realtor 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 the seller has already found a buyer, she should consider retaining legal counsel who can assist her in preparing the sales contract. The attorney can also walk the seller through the entire process through the time when settlement takes place.
An agent/broker will charge her somewhere between 2 percent and 6 percent of the sales price. An attorney will charge her on an hourly basis, and from my experience, it is usually much less expensive to retain legal counsel.
More importantly, should problems arise, the agent cannot provide legal advice.
In my opinion, whether or not there is a real estate agent in the picture, sellers should also have their attorney involved in the home-sale process.
Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. Questions for this column can be submitted to benny@sandbox.inman.com.
