Q: I am the single owner of a house I inherited in 1995. I have never lived in this house and have rented it two separate times. Tenants have now moved out and I would like to know whether or not to continue renting or should I sell now that the market value is high. What about capital gains, etc? I realize that renting at this time would make more profit than selling and putting the money in the bank at such low interest rates. However, I think selling now rather than waiting and having the cost of the sale of the house go down in a few years is a better choice. What's your advice?

Via E-mail

A: What you do with the property now should be directed by your long-term financial goals. Frankly, right now, if I inherited a property – meaning I have NO money out of my pocket to get into it whatsoever – I would hang on to it until I retired or died. This is the ultimate cash machine if you’re willing to look at the cash flow it’s generating rather than how much it’s worth at this point in time.

Real estate investors, while looking for a good time to cash in, rely on the long-term growth more than the short-term value to create wealth. You’ve only had the property eight years – how much money will it make for you over the next 10 or 20 years with an average increase in rent at the rate of inflation (let’s say 2 – 3%)?

If you’re receiving $1,000 per month in rent now, moving forward at 3 percent per year over the next 10 years would result in a cumulative cash flow of $137,520 – AND you still have the equity in the property to use later if you so desire. Why would you get rid of that? This type of return is not available in the stock market (unless you know exactly what to invest in), CD’s or any other current investment.

Another difference between real estate and cash investments is how much cash it generates per month. Let’s say the house is worth $150,000 and that it’s currently bringing in $1,000 per month ($12,000 per year) – that’s an 8% return on the value of the house. Now for you, since you inherited the property – it’s an infinite percent return on the money that you didn’t even have to put into it.

If you do sell, capital gains are going to eat you up – at the minimum it’s 5 percent of your gain - for every $100,000 in value that you’re going to get in the sale, you’re going to pay Uncle Sam $5,000. However, since this was an investment property, hopefully you have been depreciating the value of the property against your income. One of the tax rates that wasn’t lowered through the recent lowering of tax rates was the tax imposed on depreciation taken on the sale of investment real estate – the rate is still at 25 percent.

You do get to reduce your gain by the amount of the value of the house when you inherited it (called your basis), plus the cost of selling the house (commissions, advertising, points, etc.) To tell you in this space how much you’ll pay in taxes is impossible. Talk with your accountant to be sure. Unlike your personal residence, you do not get to exempt $250,000 of gain from the tax man. Below are some figures you’ll have to deal with, however.

Selling now at $150,000 would create a gross gain of that same amount. Now let’s start the reductions – 6% to sell ($9,000); a point to the buyer ($1,500); closing costs of roughly 3% ($4,500) – You’re down $15,000. Now your gain is at $135,000. If the house was worth $100,000 when you inherited it, that’s how much you get to reduce from the gain as well for tax purposes. Now your gain is around $35,000 on which you’ll have to pay taxes.

Now, the cash you’re walking away with (subtracting the cost of sale and maximum taxes) may roughly be $126,250. In the bank, that’s going to return about 2 – 3% annual return ($2,525 - $3,788). Using the above examples, you’ve cut your cash flow by as much as $7,000 per year.

With these ROUGH numbers, which do you think is the better investment? Unless you have an amazingly good deal sitting on the side waiting for your money (like a gold mine that no one else knows about) I’d keep it in the property. If you need cash, then talk with a loan officer about pulling out some of your equity. Right now, you have in your possession what everyone who writes me is looking to get – a positive cash flow property that’s building you wealth one month at a time.

Published: August 15, 2003

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