Rental House: Keep or Sell?

My long-term tenant is finally moving out of my rental house and I am again faced with the decision of keeping it or selling it. I have decided to turn to the fine minds of MIFP for advice. Here are the salient numbers.
The Zestimate on the house is $428,692. I think this is pretty reasonable. The rent Zestimate is $2,225 per month, but I currently rent it out for $2,050. I intentionally charge below-market rent to attract more potential tenants.
1st mortgage Balance: $273,350.96 Interest rate: 3.375% (fixed) Maturity date: 02/27 Last payment: $2,805.85 Principal: $1,583.38 Interest: $773.25 Escrow: $449.22
2nd mortgage Balance: $29,316.45 Interest rate: 6.125% (fixed) Maturity date: 03/25 Last payment: $329.11 Principal: $175.84 Interest: $153.27
The house is in decent shape and managing it isn't too difficult because I literally live next door. I've had problem tenants in the past (one of whom still owes me ~$8k). But once I got a good, long-term tenant, things were fine. The house is in a nice neighborhood. Of course no one really knows where housing prices are going. If I had to guess, I'd say that I expect prices in my neighborhood to remain relatively steady.
The first observation is that I'm leaking money like a sieve. The total monthly payment is $3,134.96 and I'm only collecting $2,050 in rent. So I pay $1,084.96 per month to cover the difference. But the rent covers 100% of the interest and escrow, plus 1/3 of the principal payment. So at least that money is coming back to me, albeit in an illiquid way.
Financially speaking, everything else is good. Retirement accounts are fully-funded. Emergency savings are in place. Cash flow is fine. I have considered paying off the 2nd mortgage, but I haven't been able to convince myself one way or the other on that.
Thanks in advance, Bill
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On 4/20/2015 8:31 AM, Bill Woessner wrote:

You left out whether there's a taxable gain if you do sell it, and whether you have any suspended passive activity losses from rental. On your depreciation schedule, there will be two numbers to look at: your total cost, and total depreciation to date. Cost minus depreciation is your tax basis, and you pay tax at a variety of rates on gains above that amount. Suspended losses show up on form 8582, and offset other income in the year of sale.
While rental income is less than cash costs, a bunch of your mortgage payment is going towards principal. From a balance sheet or income perspective, that's just moving money from one of your pockets to the other, rather than being a true expense. It's lowering your debt, increasing your equity. As long as you have the cash to keep that going forever it's not necessarily a problem.
Another factor I think people don't consider enough is their personal exposure to real estate prices. I see people with a home and rental property and it's 90% of their assets. That in itself can be a reason to sell when the getting is good. OTOH, you might want that house there for some personal use in the future and your renter is covering most costs in the meantime.
-Tad
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Also, does you situation allow you to take tax advantages of the negative income each year? Or are you in the situation where you have to suspend the losses? Any chance of using suspended losses against ordinary in come in the near future?
Is there any benefit in moving into the rental to turn it into your personal residence for a couple year and then selling it as your personal residence. I know they changed the rules so you really need to think this through carefully to see what the benefit might be. But don't forget the hassle factor, too.
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On Monday, April 20, 2015 at 2:00:04 PM UTC-4, Tad Borek wrote:

This is an excellent point. From my 2014 return:
Total cost: $240k Total depreciation: $51k Suspended losses: $59k
This doesn't include the cost of the land. If I had to estimate the cost of the land, I'd put it at $162k. So if I've done this correctly, I would show a taxable gain of $19k.

Another excellent point. This is especially important to consider in my situation because my house and my rental are literally next door to each other. So whatever happens to one is very likely to happen to the another. I would estimate that real estate makes up 54% of my assets. That's based on the gross value my real estate holdings; not the value net of outstanding mortgages.
To answer the question posed by the other poster, I have to suspend the loss every year. And there's no way that's going to change any time in the near future. There's also no way I would ever move back in to that house. Too much hassle - even though it's next door. Plus the new house is much nicer. :)
Thanks, Bill
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On 4/21/2015 2:15 PM, Bill Woessner wrote: > This is an excellent point. From my 2014 return: > > Total cost: $240k Total depreciation: $51k Suspended losses: $59k > > This doesn't include the cost of the land. I'd put it at $162k.
Let's say it sells for $430k less 5% selling costs, $409k net - can adjusted as needed. Basis: $240k + $162k - $51k = $351k Gain: $58k Character: most likely - $51k unrecaptured Sec. 1250 gain, $7k long-term capital gain Tax: Sec 1250 portion is at a maximum rate of 25%, rest is at LTCG rate, plus NIIT and state tax if applicable. Suspended losses of $59k released on termination of activity - tax value needs to be determined.
At a minimum, you should walk away from a sale with your net proceeds because the loss carry-forward is greater than your gain; it's a no-net-income transaction. Really, you'll do better than that because the carry-forward is applied against your higher-taxed ordinary income. You'll net the difference in tax between the $51k in gains and $58k in ordinary income.
As an investment: $26.7k market rent on a $430k asset is 6.2%. That would be a nice yield...after expenses, not gross. It's over 16X rent. Pricey for a "normal" rental property, unless there's expected upside for some reason. Looks like it's lost about $10k/year and though that's mostly from depreciation, where would upside come from? How does it ever make money?
-Tad
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Don't you add the suspended losses to the basis? Then it is a almost a zero gain/loss transaction.
Then what to do with the proceeds?
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On 4/23/2015 8:54 AM, taxed and spent wrote:

Not factored into basis...suspended losses are just no longer suspended once you terminate the activity generating the losses. In this case, terminate means selling the one rental property. But yes, with the numbers posted there is no net income. A $58k gain and $59k loss.
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On Tuesday, April 21, 2015 at 5:40:03 PM UTC-4, Tad Borek wrote:

Yeah, that's what I'm wondering. But if you take the long view, I think it makes money. I drew up a spreadsheet to model all this. It doesn't take taxes or sales commission in to account, but it does allow you to vary the rate of appreciation, rent increase and escrow increase. Adding taxes and sales commission shouldn't be too hard, but I'm pretty much done with thinking about this today. Here's a link to the spreadsheet:
http://goo.gl/4ZkUHh
Using 3.22% (the long term rate of inflation) for escrow increase, appreciation and rent increase, I get a 9.01% return over the next 12 years. It's not nothing, but it's not a slam dunk, either. I guess I'll just sell it and use the proceeds to buy the Porsche I've always wanted. ;-)
Thanks, Bill
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On 4/29/2015 5:45 PM, Bill Woessner wrote:

But that approach begs the question of whether the property is a good investment. A levered thing that goes up in value is going to look good!
By including 3.22% annual appreciation as an assumption, you're only considering the possibility that it will go up in value. That's part of what you're trying to solve for - what is the likelihood that it will go up in value? It already is priced at 16X annual market rent which sounds high for a true rental property. I'd look at the Schedule E and see if it ever turns around, or posts many years of losses. Without a reason for rents to rise more than 3.22% why will it continue to go up in value by 3.22%? It's a bit like a high-P/E stock, where you assume the P/E stays high.
-Tad
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