Dear Mr. Azrael:
A few years ago, my wife and I bought a "handyman special," fixed it up and rented it out.
The labor and repair costs have since become a burden. We believe we could sell this property for an amount sufficient to pay off both that mortgage and the mortgage of the house where we live.
We are concerned, however, about taxes on the sale of the house and also about losing the tax advantages of owning a rental property. Would it be a smart move financially to sell this rental property and pay off our home mortgage, too?
Lucas Cole Elkton
Dear Mr. Cole:
You pose two different questions.
The first decision is whether to sell your rental property. Since the repairs and labor costs have become burdensome for you, and you have a profit in the house, it probably makes good sense for you to sell it.
You will have to pay off any mortgages or other liens against the property. You will have a capital gain on the sale of this investment asset.
The capital gain will be calculated by subtracting your tax basis from the proceeds of sale (less selling expenses and settlement costs).
You will pay federal and state tax on the gain at the long-term capital gains rates.
The second decision is what to do with the net proceeds.
You should consider all the various alternatives for investment. Paying off your existing home mortgage is one alternative. For instance, if your mortgage interest rate is 7 percent annually, using the proceeds to pay off your loan is similar to investing the net proceeds in a bond or deposit/account that returns 7 percent per year.
If your home mortgage interest rate is relatively low, you may be able to place the proceeds from the sale of the rental property in an investment yielding a higher rate of return than your mortgage interest rate. On the other hand, many folks would relish the peace of mind in knowing their house is debt free.
If you want to use the sale proceeds to purchase other investment real estate, you should consider a "like-kind exchange." As has been explained in earlier Mailbag responses, a property exchange may enable you to defer the capital gains tax on the sale of your rental property.
All in all, you seem to be in a fine position to improve your cash flow. Before making final decisions on the sale and reinvestment, it's a good idea to consult with your accountant to estimate your tax liability and the net proceeds you will have to reinvest.
Questions? Real estate questions are answered by Jonathan A. Azrael of Azrael, Gann and Franz of Towson. Questions -- including name, address and daytime telephone number -- may be sent in the following ways:
Mailing address: Real Estate Mailbag, Fifth Floor, 501 N. Calvert St., Baltimore, MD 21278-0001. Fax: 410-783-2517. E-mail: real.estate@baltsun.com
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