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Renting Your Property vs Selling: The Pros & Cons

Once homeowners decide to make a move that decision usually entails selling their current home, but in today’s current economic climate that may not be the best scenario, even if they need the money to put towards their new home. Plummeting values, a severe shortage of qualified buyers and the biggest credit crunch in years may make selling impossible or a no win situation. Currently hundreds of thousands of American homeowners are facing this dim prospect. Some may want to sell and move by choice, others may not be so lucky. Unemployment, rising costs and other mitigating factors are forcing their hand. One common strategy of the past few years has been to weigh the pros and cons of selling versus renting their current home, and then decide rather than to simply put the house on the market.

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In some cases decisions are based on a temporary situation that simply demands the owners vacate for a period of a year or two. Possibly a forced job relocation that is for a moderate period of, the need to pursue higher education in a different local, or in the worst case scenario, a family emergency that require less expenditures and a bit more ready cash.

In some regions values may be diminished to the point that it just does not make good financial sense to sell, and a waiting period intimates that a better price and a greater ROI (return on investment) could be realized if the sale is postponed a year or two. This scenario is becoming more and more evident across the nation.

Regardless of what prompts someone to either sell or rent their home they need to first understand all the factors that will influence their choice, and most importantly the final outcome of that decision.

How does selling influence your taxes?

The government provides liberal tax shelter for those who have resided in their home for no less than two years during the past five. If it is a married couple who are jointly filing they can earn up to a half million dollars in capital gains free of taxation. Singles are allowed the same benefit on any gains under a quarter million. (As the laws and capital gains caps are subject to change it is best to always check the current allowances before calculating the taxes on a sale.)

As stated above the government has also been generous in allowing homeowners who have rented their property for two years or less, but if they should decide to sell more than three years later the tax exemption mentioned is disallowed, and the capital gain would once again be subject to taxation.

Therefore, if the homeowner is able to know in advance what their situation will be in the future, and they assuredly know that their decision to rent would nullify the tax-free gain, selling becomes their preferred option. The government offers one other alternative to this scenario. If the owners move back to their property and reside there for two more years the exemption would then again be allowed.

How does renting influence your taxes?

Selling a property is not the only way to take advantage of tax breaks. Sure, rental income is taxable, but the numerous deductions that are available can at times offset the taxes completely when deductions for expenses and depreciation are factored into the equation.

With most tax issues there are caveats and pitfalls to be cautious of. If you are renting out your property and claiming these capital-gains deductions, and then you decide to sell for whatever reason, you will be taxed on the amount that you depreciated. This one aspect could make renting less advantageous. Be certain to consult your tax attorney or financial advisor before making any decisions that might have the ability to work against you in the future.

The three classes of deductions.

Expenses: For the most part any and all expenses can be deducted if they are related to ownership or management of a property. Similar to the property being a primary residence, the mortgage interest payments, if they exist, and property taxes can come right off the top, too. If you utilize an agent, broker or management company to advertise, show and lease your property those expense may also be deducted. Repairs and maintenance are also considered to be legitimate expenses and can amount to a considerable sum. Utilities, and also fire and liability coverage can also fall under this class of deduction. Some people have also deducted the costs incurred for traveling to their rental property when it is for a management or rent collection expense. If there investor has more than one property this can actually be a full time job for the person involved and traveling expenditures will add up.

Depreciation: Annual depreciation is figured with a rather straightforward equation. Divide the Fair Market Value of the property from the date it was first rented (excluding the land) by its recovery period which is factored at 27.5 years for a residential rental property.

Home Value of $300,000 ÷ 27.5 = 10,909 in allowable annual deductions.
Add in theoretical out-of-pocket expenses totaling $7,000 = $17,909 in tax-free rent.

HV ÷ 27.5 + Ex = Total Tax-free Rent

Although improvements to a home cannot be directly deducted you can recoup the costs through depreciation over a five year period. For example, an appliance that costs you $2,000 is worth $400 per year as a deduction against the rental income. (As the laws and deductions are subject to change it is best to always check the current allowances before calculating your taxes or consult a financial, accounting, or tax expert.)

If you are faced with deciding to sell or rent consider these points, too. Renting entails a lot of time and effort, and a reserve of cash for the normal and hidden contingency that can arise. If you do not have a bumper of cash to protect you when renting major financial difficulties can ensue. Multiply those by two or three homes and you are now in a totally different league.

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