Real Estate: Sell or Rent?

To Sell or to Rent Out? That is the Question.

Roy Wakumoto’s tale of homeownership is familiar: from homeowner to landlord and back. Wakumoto bought his Salt Lake condominium as a bachelor pad. Then he moved in with his girlfriend and rented it out. He held onto his condo as a landlord until this year, when he decided to sell, as home prices started to climb. “I sold the unit because I could finally get back the equity; I wanted to sell it before I lost the equity again,” he said.

Maybe there was a time when Americans bought one home to last a lifetime, but that is not the case as much anymore. People move around. Things change. Life plans get drawn up and redrawn. For whatever reason—a kick-ass job offer in another state, an empty nest, divorce, wanderlust—it’s time to get out of that house you’ve been living in. Time, especially, to turn that house into some serious cash.

You’ve got two choices: Sell it for big money up front, or rent it out for steady money in the long run. Wakumoto said selling is a no-brainer if you have just enough income to pay your monthly bills, and need the proceeds from the sale of your current home to buy your dream home. But what if, as is the case for many people in the state, your home has appreciated significantly, or your income has increased to the point where you think you could go either way? Which way should you go? What can you expect out of either choice?

You Should Sell Your House…

… If you expect home prices to decrease. James Lewis, a Realtor with Coldwell Banker Pacific Properties, says, “Many times, in this particular market, there’s been rapid appreciation … so it makes sense to sell, especially if you’re an owner-occupant.” Selling qualifies you for a tax exemption on a maximum of $500,000 in capital gains on your home for a married couple filing jointly, or $250,000 for a single person. Generally, gain is the difference between the price you paid for your home (plus capital improvements) and the price the buyer paid for it. “If you have more than the $500,000 maximum exemption, then there will be taxes to pay,” says Hedburg. Generally, if you’ve never rented out your place, there’s 15 percent in federal and 7.25 percent in Hawaii state taxes. In contrast, rental income is taxed as ordinary income, plus the 4.5 percent general excise tax, and a transit accommodation tax, if your home is rented for less than 180 days.

…If you’ve lived in your primary residence for at least two out of the last five years. CPA Jeannie Hedburg says the two-year requirement is based on a federal law meant to benefit seniors who may need to live in a care home temporarily. “That way, they aren’t forced to sell their homes if they aren’t emotionally ready,” she says. With the law in place, she says, those who want to live on the Mainland for a few years can rent out their properties without losing out on the exemption.

“I look back 60 months from the date to close—if it’s been your primary residence for 24 months out of the 60 months, even if you’ve been in and out, you still get the tax exemption,” she says.

… If you’re leaving the state and are definitely not coming back. But be sure about it. The allure of new, lower-priced, large homes on the Mainland has enticed many homeowners in Hawaii to sell, pack up and move, only to regret it. “Once you’ve sold and moved, it can be very difficult to reverse the process. You may find you’ve been priced out of home ownership in Hawaii,” says Lewis.

You Should Rent Out Your House…

… If you expect home values to remain stable or increase in three years. Lewis says, “Historically, real estate continues to increase in value over time. So keeping a property and renting it out will add to your net worth as the value increases.”

… If your income from rent covers mortgage and other expenses. Hedburg says that, while rental income is taxed as regular income, meaning you pay 4.5 percent general excise tax annually, you can deduct your expenses, and actually only pay taxes on whatever is left over. “In most cases, there’s nothing left,” she says, “You can collect $1,000 a month in rent and pay out that same amount after paying the mortgage, maintenance fees, repairs, sewer fees, etc. In that case, you’re holding onto the property for future appreciation.”

There’s also the deductible from depreciation. To get this figure, divide your property’s fair market value at the time you start renting it out (excluding the cost of land) by 27.5 years—the recovery period for residential rental properties. For example, an Oahu home worth $550,000 divided by 27.5 years gives you a $20,000 tax deduction from your rental income.

… If you’re financially able to make payments on two homes, at least for a few months. There’s no guarantee that your rental will be occupied continuously. Renters may be uprooted for any number of reasons, leaving you with two mortgages to pay while you look for new tenants.

… If you’re Handy Andy and are ready for emergency repair calls 24/7. How comfortable are you with making basic home repairs? Do you have a list of favorite contractors you can call in a crunch? Wakumoto said he got around that issue by telling his renters that he, “charged lower than the market rate for rent, and, in some cases, I never raised the rent, as long as they did minor repairs. If they were going to call me for every little thing, like, oh, the towel rack fell down, then forget it, they weren’t going to work out.”

… If you’re not handy and think that 10 percent of the rent is a small price to pay for a good night’s sleep, you may want to consider hiring a property manager. Property managers can be hired for selective tasks, such as finding tenants, or for the whole shebang, doing everything from advertising the property, checking prospective tenants’ financial backgrounds, collecting rent and paying the bills. If you give a property manager total responsibility, make sure you get a monthly statement of income and expenses so you can keep track of where your money goes.

The biggest factor in the rent-or-sell decision is what’s going on in your life right now. According to Hedburg, “There’s no one-size-fits-all. It depends where you are in your life cycle, what’s important to you and which option fits more of what you want in your life.”

Doing Your Homework

To rent or to sell? One way to figure which option is right for you is the purely financial equation—which one pays better? Some advisors, such as Forbes, suggest that you divide your rental income by the expected sale price of your home. This will give you the investment yield. Compare this to the yield on long-term Treasury bonds, which pay interest semiannually (as of early March, the rate on a 30-year bond was 4.73 percent).  If your yield is less than the T-bond, Forbes says you’re better off selling. An online calculator, at forbes.com, will do the number crunching for you, but, if you use it, you have to do some homework. To figure out if renting is worth it, you’ll need to know:

Your expected annual rent.
A quick survey of the classified ads will give you a hint.

Annual taxes:
On a rental, you will continue to pay property taxes.
Like any business, you’ll need a general excise tax license and will pay a 4 percent general excise (G.E.) tax. How often you file depends on how much taxes you’ll pay—semiannually if your taxes are $2,000 or less, quarterly if $4,000 or less and monthly if $4,000 or more.

If you sell, you’re subject to a capital gains tax. The good news is that you may be exempt from this tax if the difference between the price you paid for your home and the probable selling price is $250,000, if you’re single, or $500,000 if you’re married. If you earn more than that, then you’ll pay 15 percent in federal taxes and 7.25 percent in Hawai‘i state taxes.

Other annual costs:
These include capital improvements, i.e., work that prolongs the life of the building or adds to its value, such as roof replacement and exterior painting.

Monthly fees not paid by tenant:
These could include anything from electric to cable bills, landscaping, water and condo fees.

Likely sale price of your home:
Peruse www.brokersmls.com to see what homes are selling for in your area. If you’re working with a realtor, he or she will be able to tell you actual sale prices.