Question: We were gifted a house valued at $250,000, with no mortgage. The home we live in is valued at $300,000 with $145,000 on the mortgage.
We are thinking about selling the home that we live in and remodeling and moving into the gifted house, which would be mortgage-free.
Since we both still work and make a good income, I feel we will be paying huge taxes every year without a mortgage write-off. So I want to rent out the house we live in now for tax purposes and investment down the road. Or we could take the cash from selling our home and put a down payment on a smaller house and rent that out for the rental income and tax deductions.
My husband does not want to rent, fearing what some renters can do to a house; he thinks we would be fixing up the rented house all the time.
What do you think is the best investment for us without getting hit hard with paying taxes every year?
Answer: There is no “right” answer to your question because it depends on your personal financial need and goals, as well as your tolerance for risk. It sounds like you are more of a risk taker than your husband, so you’ll need to come to some sort of agreement on how much financial risk you are willing to take before you can decide on a course of action.
Here are some things to consider.
The real estate market in the Puget Sound region is starting to pick up, but probably will not experience the same kind of rapid appreciation that we saw in the first half of the last decade, at least for a couple years. If you are looking at it as a long-term investment (10 years or more) it might make more sense, but there may be better places to invest your money over the shorter term.
Property management is another issue. If your husband is adamant about not wanting to take on the responsibilities of managing a rental property, it is probably not a good idea — unless you intend to do all of the work yourself or hire somebody else to do it for you. As I have written before in this column, if you want to be a successful real estate investor you must take it seriously and treat it as a business. If you are not prepared to spend time screening prospective tenants and managing the maintenance and repair of a rental house, you are better off selling your house and investing the cash in stocks, bonds or some other kind of passive investment.
If you decide to keep the house as a rental, be prepared for a long holding period. For example, I own two rental properties that I bought back in 1989 and 1990 when the housing market was hot. The housing market then cooled off during the early 1990s and the value of those rental properties did not appreciate very much at all for several years. Then we had two hot housing markets in the late 1990s and the mid-2000s, and today those two rental properties are worth three times the price that I paid for them, even after the recent decline in home values. If I had sold them after a few years, I would have made a very small profit. So real estate works best as a long-term (10 years or more) investment. And keep in mind that home prices are still relatively high, so don’t count on doubling your home’s value even if you hold it for 10 years. We may not have a huge amount of home price appreciation over the next decade.
As for tax deductions, I am NOT a big fan of buying real estate as a “tax write-off.” The tax benefits are nice, but they should not be your primary reason for buying or holding a rental property. And they can always change the tax laws and that deduction could go away. Too many people rationalize holding onto a money-losing property because “it’s a good tax write-off.” In my opinion, you should never buy (or hold) a rental property unless it is at least breaking even. If you don’t have enough rental income to cover all of your expenses, you are just throwing good money after bad and hoping that home price appreciation will bail you out in the future. That is a very risky gamble. Who knows how long it will take for home prices to get back up to anywhere near the peak prices of 2007? In the meantime, your rental property had better be paying for itself — and preferably generating a positive monthly cash flow — during the holding period.
I hope this gives you some ideas to discuss with your husband to make a decision. As I said above, there is no “right” answer. You just have to find the solution that best fits your financial needs and goals.
Steve Tytler is a licensed real estate broker and owner of Best Mortgage. You can email him at firstname.lastname@example.org.