Long-Distance Home Ownership - The Good, the Bad, and the Ugly
Long-Distance Home Ownership - The Good, the Bad
, and the Ugly
It had seemed a good idea to keep the home just north of Cincinnati when Hesse received PCS orders for a base 1500 miles away. He'd had good tenants for two years, but then he hired a local real estate agent in 2002 to serve as property manager for new tenants.
Bad tenants, and a bad property manager who didn't know how to evict them, resulted in the bad day for Hesse who thus found himself pitching the garbage bags, one by one, out his front door.
He's returning this year to retire in that home. So what did this long-distance owner of property learn? "Both my successes and failures came down to whether or not I did my homework, whether I was managing it myself or having someone else do it," Hesse concludes. "It's not about managing property but about managing people."
Not everyone plans to return to live in the house they leave behind after a PCS. At one time, Desley Sant Parker, Commander USN (Ret.) and husband Brance James Parker, Captain, USN (Ret.) owned a primary residence and three rentals. Selling one of their rentals, too small for the dream retirement home they wanted, provided them with the cash for a second vacation home/rental. "If you can only manage to have one rental," says Desley Parker, a Florida-based Certified Success Coach, "keep one in the area you may want to retire to. Even if it is not the home you retire to, it will provide you a foot in the market."
Unlike Hesse, the Parkers liked a hands-on experience that saved money and allowed "relationship building" with tenants and continued connection with the community.
Dollars and Sense
Do it yourself from afar (either hands-on or through a friend or family member) or hire out management? The typical 10% paid to a property manager would seem a simple calculation -- until you factor in the requirement of some management companies of a minimum amount of capital to remain on deposit for unexpected repairs, bringing initial costs up even higher.
Philip Dyer calls those surprise factors, which also include unplanned vacancies and setting rental rates too low, the "alligators" that slowly eat a landlord one bite at a time. Major Russ Perkins, US Army IN, Active duty, who has owned several rentals, advocates "counting the cost" ahead of time and setting aside a minimum of six months' mortgage payments to stave off such alligators.
But there's money to be made on residential real estate. Philip Dyer, MOAA's deputy director for financial education, points out: "Any loss - real or paper - taken on the property is an 'above the line' deduction on personal income taxes, which directly affects a taxpayer's adjusted gross income (AGI). You can deduct mortgage interest, property taxes, repairs, management fees and two annual visits to the property for inspection from your gross rental receipts."
Dyer and California-based David A. Shaw (who served in the USAF, Space Command, before becoming an a tax expert known as an Enrolled Agent, licensed by the federal government to represent taxpayers before the IRS) give the following military-specific pointers about long-distance home ownership:
Go with a plan. Shaw points out that it matters if a house is a primary residence or intended to be such for retirement, because a rental property will always be depreciated (allowed or allowable by the IRC, whether or not it's taken.) "The loss created by the rental activity, including depreciation, is limited to $25,000 and is subject to a phase out when AGI is between $100 - $150,000," says Shaw, who also cautions that not all repairs or improvements are fully deductible the year of the expense, and may be subject to state laws that may differ from federal ones.
State your state. "If the home is located in a state in which the officer has no income from other than the rents," says Shaw, "he may still have to file an income tax return with the state the home is located in [resulting in] a tax liability in not only the state of his home of record, but the state in which the property is located as well." Two state returns may be necessary for "snowbirds" who don't rent out a second home, but use it as a residence part of the year. However, if it is treated as a second home or vacation home, says Shaw, "the interest on the mortgage and property taxes are deductible similar to a person's primary residence." Such a second home cannot be rented out for more than 14 days a year.
Plan for Tax Issues if you Sell: A primary residence you live in for two of the five years immediately preceding the sale qualifies for a $500,000 exemption on income taxes ($250,000 for single filers), says Dyer. However, you can move back into a rental property, re-convert it to a principal residence and sell it after the proper holding period (two out of the preceding five years from the close of escrow on the original sale.) Thus you can requalify the property for exemption, though you must pay depreciation recapture taxes at a flat 25% on properties if the depreciation is taken or allowed after May 6, 1997.
Repair or Improvement? "In the case of a rental, all ordinary and necessary expenses to maintain the home as a rental are deductible to offset the rent income," says Shaw. "Do not confuse improvements as expenses as they are subject to depreciation and the rules that apply to depreciable assets."
Passive or non-passive? "If a person manages the rental property themselves, they have normal income from a non-passive activity," says Shaw. "Should they choose to have a management company handle matters for them, they take a passive role. Thus, they have passive income or loss. A non-passive activity will be allowed to be deducted.... but passive activities that create a loss are only used to offset passive income. "
Just rewards
Long distance home ownership can be a powerful tool for building wealth, given the ideal of low vacancy rates and maintenance costs. Albuquerque resident Senior Master Sergeant Shannon Roberts, USAF (Ret.), for instance, has successfully juggled rent properties through his career, with the only regret that he wishes he'd started earlier. Dyer says that some retired officers accumulate 6-8 properties during a typical military career and can gain considerable equity while letting someone else make the mortgage payments.
Property Abroad and Snowbird Issues
What if your rental is overseas? In terms of income, Shaw says there's no significant difference because you'll probably hire a property manager who'll send you net proceeds that will be taxable.
Dyer says snowbirds--those who legitimately spend equal time in two domestic locations-can choose one location (usually the one with the best tax structure, such as Florida or Texas) as the domicile state to keep more earnings from pensions and Social Security. "By changing the domicile state to one with no state income tax, they can save significant amounts on state income taxes, since most part-year resident tax laws only applied to earned income, not retirement/pension plans," says Dyer.
Shaw, however, offers a note of warning: "I have seen states try to go after snowbirds in an attempt to establish domicile. Theory is correct, but make sure you have a strong position that the nontaxable state. . .is your true domicile."
Some snowbirds skirt the whole distance issue with recreational vehicles, which usually qualify as second residences. For instance, Arnold L. Payne (Technical Sergeant, USAF Ret. E-6), and wife Mary Ann "go anywhere we want," says Mary Ann. Their long-distance home maintenance issues of their primary home in Lynnewood, Washington, are handled by their daughter, while their "vacation home" is located anywhere its wheels will take it, with a new picture-window view every day if they wish.
Advice You Can Use
Homework, homework: Investigate a property manager. Investigate prospective tenants. Don't sign a contract you can't understand with a property manager. And don't issue a renter's contract you can't understand.
If possible, buy near a base where renters will be military. Points out Rob Harol, product manager for financial services at Military.com., you have recourse resources: "You get a little more peace of mind than the average landlord if they are renting to fellow military members."
Don't buy a "quaint" house. Buy a practical, three-bedroom, two-bath house that rents quickly and will sell quickly if you need it to.
Consider a home warranty company. For a small monthly fee (and sometimes a nominal trip charge) they'll repair any appliance and/or system they've warranted.
Get over how it looks: Remember, you can always repaint or put in new carpet if and when you decide to live in it again.
Latayne C. Scott has published hundreds of articles in national magazines, including Military Officer, Today's Officer, Writer's Digest, Guideposts,Texas Business, NFPA Journal, New Mexico Magazine, Albuquerque Journal, Sage and many others. She writes on finances, utilities, retirement, robots, consumer issues, writing and publishing, cults and a host of other subjects. She has also written 13 non-fiction books published by major genre publishers.
Visit her website athttp://tinyurl.com/cvwdjy for more information.
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