Welcome to Day Nine of the 30 Day Financial Transition Challenge. Today’s article focuses on your rental real estate exposure, specifically if you’ve become an accidental landlord at some point in your career. You might not own any rental property, or only own the home that you plan to live in after transition. In that case, you might choose to review some of your previous checklist items and make sure you’re tracking what you need to do so far.
Bottom Line Up Front (BLUF)
If you own rental property, it’s important to know what your long-term plan is for it. If your plan is to sell it in the near future, then you should realize the tax implications. These implications can be vastly different once you leave active duty, and the difference in your tax bill can be thousands of dollars.
Over the course of a career, many military families buy a house, then become accidental landlords. Whatever the reason, if you don’t have a long-term plan for your rental property, then you run the risk of:
- Having to put more money into it than you’re getting out of it
- Becoming stressed due to the demands of property management
- Paying more money than you should to get out from under it
Your goal should be to figure out:
- Whether your rental property is viable for the long run
- Whether you’re going to sell your rental property before you transition
- Next steps if you decide to sell your rental property
- Three Tax Considerations When Selling Your Rental Property in the Military
- 9 Tax Considerations For Transitioning Servicemembers
- Eleven Real Estate Lessons I Learned as an Accidental Landlord
What you need
You need the records that you use in managing your rental property. You should also be able to reach other important documents like your mortgage paperwork, as well as your prior year tax returns.
1. Is my rental property viable?
- Is it profitable? You might have your rules of thumb on determining this. However, you need to make sure you’re accounting for long-term maintenance, repairs, etc. A rule of thumb is known as the 50% rule: 50% of your rent should cover your mortgage, and the other 50% of your rent should be able to cover:
- Property management
- Taxes & insurance
- Repairs: Set aside 10%
- Capital Expenditures (like replacing AC system, appliances, etc): Set aside 10%
- Vacancies: 10%
- If your property meets the 50% rule, then it might be viable in the long term. If not, you might want to consider selling it.
2. Other considerations include:
- Does managing the property stress you out?
- Are you able to sell and make money (or at least not bring a whole lot to the table to close)?
- Section 121 tax exclusion: There is a 10-year extension of the ‘2 for 5’ year rule that applies to military. Once you leave active duty, this goes away…you might no longer be eligible to exclude the first $250K ($500K if you’re married) in profit if you sell after leaving active duty.
3. If you decide to sell, here are some things to think about:
- Do you know a good real estate agent?
- Can you get an estimated selling price? Does this price make sense?
- Do you need to do maintenance or repairs, or are you willing to discount the selling price to allow for repairs?
- When does your lease expire? Can you break the lease, or are the tenants willing to do so?
- What’s your timeline? Can you close before your transition?
4. Tax implications: If you sell your rental property, you absolutely need to:
- Set aside money from your closing for your tax bill. Regardless of your Section 121 exclusion, you will owe taxes for depreciation recapture. This will be a flat tax of 25% of all the depreciation you’ve been eligible for (not just taken) since you started renting the property.
- Hire a tax professional to do your taxes for the year that you sell the property. While you might be able to eke out a tax return on TurboTax, you want to make sure you have a professional calculate your tax liability. You can find a CPA or enrolled agent in your local area who should be able to help.
To wrap up, today you’re going to:
- Determine if you’re going to keep or get rid of your rental property
- Establish a checklist, such as finding a real estate agent, hiring a tax professional, determining what repairs you need to make, etc.
Tomorrow, we’re going to take a look at your property & casualty insurance coverage. This includes your car, home, recreational vehicles, and umbrella insurance. It’s important to make sure you’re properly covered for these risks, and at the right price.