If you’re ready to move out of your home in the San Francisco Bay Area, or anywhere, you may be debating the most educated next step. Should you sell or, assuming you’re in a financial position to contemplate holding, should you rent? While an experienced real estate agent should have a big well of insight to tap, it can be helpful to understand four main elements of the sell-versus-buy consideration.
Cash Flow Analysis & Tax Implications
First things first—you need to assess rental value minus your costs, which include mortgage, insurance, taxes, and miscellaneous expenses. From there, you can determine whether you’re cash positive or cash negative.
In a positive cash flow scenario—uncommon in San Francisco, by the way—tax implications are the next consideration. Once you’ve rented it, the property becomes an investment property and must therefore be depreciated. If the depreciation exceeds cash flow, the result is book income and a tax loss that must be recorded on schedule E of the tax return and suspended until the property is sold. Once it’s been sold, the depreciation is re-captured, and any suspended losses are deduced from the gain.
It sounds complex, but the math is actually quite simple.
The second consideration is that the clock starts ticking on your owner-occupied tax exclusion. If you occupied the home as your principal residence and you have any kind of appreciation, you’re allowed to realize a tax-free gain of $250,000 for a single person and $500,000 for a married couple. The trick is that in order to take advantage of that, you must be able to claim the property as your principal residence for two of the last five years. That effectively means that you have three years to rent the property before you lose the tax savings. Add the fact that Congress has been tossing around losing the owner-occupied tax exclusion of late, and it’s a significant chunk of taxes you may be faced with paying when/if you do decide to sell.
The third consideration is whether you have the temperament and flexibility to be a landlord. Many of my clients attest to getting a property manager to deal with the hassles, but that is easier said than done. Good property managers are in short supply, and you need to account for the possibility that you may find a tenant that misses his rent or does damage to the home.
If homeowners aren’t intimidated at this point, rental laws must also be discussed. In San Francisco, these are particularly comprehensive and detailed, and to be frank, pose a reality that often sways even the most liberal of property owners to the “sale” side of the equation. California also has state tax laws that are layered on top of San Francisco, Berkeley and other county laws, none of which are for the feint of heart and none of which I will touch in terms of counseling my clients. However, I do have some amazing landlord attorneys I refer people to for that touchy and oft-changing topic.
So When Does it Make Sense to Rent?
Simply put, when you’re looking to hold an asset that you want to continue to appreciate for the long term. When you’re already maxed out in the stock market and would like an additional hedge against inflation, there is no better asset than real estate for that. And most importantly, when you have the financial flexibility to take a possible month (or six month loss), it all makes sense.
If you need help with your particular situation or you’re thinking of becoming a landlord, you know where to find me. I’m happy to be a sounding board to help you talk it out and/or offer recommendations to trusted vendors for counsel.