Q. Is there any relief for people who have to sell their rental properties to pay for their main property because of financial difficulties? We own a rental property and plan on selling because about 10 years ago, we took out a loan to improve our home but then that same year my husband got laid off for the first time out of three. We need this income to help pay the loan off and reduce our mortgage. I also lost my job.
— In trouble
A. We’re sorry to hear you’re having a tough time.
There are some strategies that may help, but you may not like them.
First, your rental.
When you own rental real estate, you can have your cake and you can eat it too, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown.
He said according to tax law, your building — but not the land — is slowly losing value due to wear and tear. This wear and tear is called depreciation.
“Rental real estate depreciation is recorded on a straight line basis over a 27½ year life. Depreciation expense is a non-cash expense that saves you taxes,” Kiely said. “You can keep your cake, too. You keep it because on paper your property is losing value; but in the real world it is increasing in value.”
Depreciation is a double-edged sword, Kiely said.
Each time you take a depreciation deduction on your tax return you save taxes, but you are also reducing your cost basis, he said. When you lower your cost basis, you are increasing the ultimate profit you will realize when you finally sell your property.
“The depreciation deduction saves you taxes at ordinary tax rates. When you sell the property the gain is taxed at the much lower capital gains rates,” Kiely said. “If you keep the property for the entire 27½, years you will reduce the cost basis of the building — not the land — to zero. If you do that, 100 percent of the proceeds will be subject to capital gains taxes.”
You ask if there is any relief for people that have to sell a rental property because of financial difficulties.
The short answer is no.
Kiely said the answer is still no regardless of the nature or type of property you are selling. It can be real estate, stocks, bonds or mutual funds.
“It’s sad that you and your husband lost your jobs and face financial difficulties. But the law is the law,” he said.
You took out what sounds like a personal loan to improve your principal house. You also have a rental property and you are both unemployed.
Kiely said when you sell the rental property, you will have to repay any mortgages on the property. These payments are made automatically at the closing table.
“The buyer’s attorney will issue you a form 100-S with a copy going to the IRS, so the government knows you sold the property and how much you got for it,” he said. “They will be looking for the sale to be on your tax return.”
It appears you have two painful choices here: bankruptcy or reorganizing your entire financial life.
On bankruptcy, Kiely said, if you have negative net worth — your liabilities exceed your assets — you might be able to file for bankruptcy. In bankruptcy, you lose almost everything, but you start over with a clean slate, he said.
The other option is to reorganize.
Kiely said you’d look at your overall situation, consider selling everything, paying off your debts and starting over.
“Another possibility is sell your principal home, pay off the mortgage and loan and move into your rental property,” Kiely said. “That way you would postpone the inevitable capital gains tax.”
He recommends you consider a visit to a fee-only financial advisor to review your situation. Or send us a note at moc.p1513615124lehye1513615124nomjn1513615124@ksa1513615124 if you’re interested in a free money makeover.
Email your questions to moc.p1513615124leHye1513615124noMJN1513615124@ksA1513615124.