My wife and her sister inherited their mother's house in the Los Angeles area 7 years ago. They have been renting it out since then, and have generally had good tenants. They have a manager who handles most of the routine issues. My sister-in-law is now thinking she may want to sell the rental house, or at least her share of the rental house. Here are the details:
House market value: $683,000
Net proceeds if sold: $640,000 assuming 6% commission and net of small capital gain tax liability
No mortgage
Property taxes ~ $2,600 per year
The house currently produces net cash flow after expenses of $24,500 per year, of which $10,500 is depreciation expense which is tax deferred, and would be taxed at the capital gains rate if and when the house is sold (as I understand it). $24,500 cash flow on a $640,000 asset is a return of ~3.8%. Property taxes are low due to Prop 13, and the rent has been raised regularly and will probably continue to go up in the future. Who knows where Los Angeles area real estate values will go, but at least there is the potential for future appreciation.
If we had an extra $320,000 lying around looking for an investment opportunity, I would probably recommend just buying my sister-in-law out. But we don't. So I see two main options:
1) Sell the house on the market as SIL wants, and invest the $320,000 proceeds in my wife's taxable investment account.
2) Take out a mortgage to purchase SIL's 50% interest in the house. We could go with a 5/1 ARM or 7/1 ARM perhaps at 3-3.5% or so, which would be marginally cash flow positive.
What do bogleheads think? Are there other options I haven't thought of?
Should my wife buy her sister's share of their rental house?
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Should my wife buy her sister's share of their rental house?
De gustibus non disputandum est
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Re: Should my wife buy her sister's share of their rental house?
Are you long distance landlords, or do you live locally? If long distance, I would definitely sell. Do you currently have good tenants? if so, try to convince you SIL to wait for the lease to expire before putting it up for sale, as it is very hard to show while occupied.
Ralph
Ralph
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Re: Should my wife buy her sister's share of their rental house?
We currently live long distance, which has not really been a problem because we have a local manager. We are moving much closer (1 1/2 hr drive away). So distance itself doesn't seem to me to be an issue - it hasn't been for the past 7 years.
De gustibus non disputandum est
Re: Should my wife buy her sister's share of their rental house?
It is my understanding your depreciation will be taxed as recapture, and the recapture rate is 25%. This can be a slight advantage if your current marginal tax rate is over 25%.cadreamer2015 wrote: The house currently produces net cash flow after expenses of $24,500 per year, of which $10,500 is depreciation expense which is tax deferred, and would be taxed at the capital gains rate if and when the house is sold (as I understand it).
Your capital gains will be taxed at the cap gains rate.
Are you a LL of other properties? If you did not currently own this house, would you go out looking for a similar residential investment property to get a mortgage on? Is there some reason to think this particular property will appreciate more than the stock market, or do you just hope it will?
The problem with holding residential rental property for 10-15 years is that it starts to age. While you may be perfectly fine living in a house with a 15 year old kitchen, and even happy to buy a house with a 15 year old kitchen, when renters are looking, they want the newest amenities, and it become difficult to rent when things age.
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Re: Should my wife buy her sister's share of their rental house?
One option that you and your spouse can consider is a 1031 or "like kind" exchange of the rental property for another rental property. It would allow you to defer recognizing capital gains on the sale or exchange of this property and you can keep getting a depreciable stream of income, positive cash flow. More information is here: http://www.nolo.com/legal-encyclopedia/ ... anges.html A good realtor can help you with this, if it is something you are interested in. You may also need a 1031 attorney to be sure the proper paperwork is done; it doesn't add much to the cost of the transaction and does allow tax deferral.
It really all depends on what YOU and your spouse want to do and what makes sense in the short and longer term. You may wish to consult with your CPA/tax planner to think of the pros and cons of the different scenarios.
It really all depends on what YOU and your spouse want to do and what makes sense in the short and longer term. You may wish to consult with your CPA/tax planner to think of the pros and cons of the different scenarios.
Re: Should my wife buy her sister's share of their rental house?
Whether is makes sense or not, I would consider a third option: "Buy" the sister's half interest in the house with a modest amount of cash and the sister takes back a mortgage for the remainder.cadreamer2015 wrote:My wife and her sister inherited their mother's house in the Los Angeles area 7 years ago. They have been renting it out since then, and have generally had good tenants. They have a manager who handles most of the routine issues. My sister-in-law is now thinking she may want to sell the rental house, or at least her share of the rental house. Here are the details:
House market value: $683,000
Net proceeds if sold: $640,000 assuming 6% commission and net of small capital gain tax liability
No mortgage
Property taxes ~ $2,600 per year
The house currently produces net cash flow after expenses of $24,500 per year, of which $10,500 is depreciation expense which is tax deferred, and would be taxed at the capital gains rate if and when the house is sold (as I understand it). $24,500 cash flow on a $640,000 asset is a return of ~3.8%. Property taxes are low due to Prop 13, and the rent has been raised regularly and will probably continue to go up in the future. Who knows where Los Angeles area real estate values will go, but at least there is the potential for future appreciation.
If we had an extra $320,000 lying around looking for an investment opportunity, I would probably recommend just buying my sister-in-law out. But we don't. So I see two main options:
1) Sell the house on the market as SIL wants, and invest the $320,000 proceeds in my wife's taxable investment account.
2) Take out a mortgage to purchase SIL's 50% interest in the house. We could go with a 5/1 ARM or 7/1 ARM perhaps at 3-3.5% or so, which would be marginally cash flow positive.
What do bogleheads think? Are there other options I haven't thought of?