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Background: In the last newsletter, I discussed a one bedroom, condo my wife, Mary Lou, and I owned as a Waikiki hideaway. In December 2006, we appealed the assessed value for taxes for the condo. Our appeal was rejected in November 2007; however, it worked out to our benefit, as someone who had heard about our unit appeared out of the blue and offered to purchase it even though it was not listed for sale. Our high-assessed value for taxes was useful in supporting a counter offer by us on price. In this section of the newsletter, I’ll discuss the various options available to us.
NOTE: The Stott Team is not licensed to provide either tax or legal advice. Licensed professionals such as attorneys or CPA’s should be consulted for such advice.
We had owned a condo in Waikiki for about ten years, first a studio unit with a golf course view in Fairway Villa and then a one-bedroom unit with a spectacular ocean view in Aloha Towers. A typical Saturday would often find the two of us attending a movie in Honolulu in the afternoon, then a short drive to our condo, walk to one of a number of nearby restaurants for dinner, spend Saturday night at the condo and return to our house Sunday morning.
In 2005, we gutted and completely remodeled the Kailua Beachfront house that had been a home to us since 1977. During the remodeling, we put most of our furniture, personal affects, etc. into storage and moved into the one-bedroom Aloha Tower unit for about ten months. After ten months of actually living in Waikiki and with a completely remodeled house, we found that going to our small hideaway had lost much of its charm. The unexpected offer forced us to make a decision we should have seriously considered a year or two earlier
This article was developed from my January & February 2008 E-Mail Updates. In them, I explained that we had sold the unit and outlined some of the options available to us. This was then followed by a series of e-mails with several of the recipients discussing various options. This newsletter goes to several attorneys/CPA’s as well as to some very experienced investors/realtors. If any of you know of options I’ve overlooked, please advise me. For space considerations, I have deliberately omitted various tax saving/deferment techniques such as an installment sale or establishing a charitable remainder trust.
For about two years, Paul Brewbaker, the Chief Economist for the Bank of Hawaii has maintained that the next period of rising prices on Oahu will begin sometime in the 20-teens, refer to page #8 of the newsletter. Using the middle of the 20-teens or 2016 as the start of rising prices and a 2-year rise until the market peaks, we would be selling our condo in about 10 years if we had decided to hold on to the unit to maximize the sales price.
Our condo unit had been totally upgraded by us about five years prior to the sale with all new appliances, cabinets, countertops, furniture, carpeting, tile, etc. We sold it fully furnished in turnkey condition. Included was artwork as well as a large HDTV. The sales price was an excellent $500,000. If we had rented it for a year to have it qualify as investment real estate, it is unlikely we could have found another motivated buyer wiling to pay anywhere near that price in our slumping housing market; moreover, there would have been rental wear & tear.
If we had waited for the next soaring housing market to sell; i.e., 10 years, an increase in value of 30% to 40% might be reasonable based upon historical Oahu housing markets. This would correlate to an increase in value of $150,000 to $200,000. From an investment viewpoint, would it be better to take our equity and invest it elsewhere or wait for the next soaring market?
Five Unknown Factors: With any investment, there are unknown factors that can impact upon the results of your decisions. As this is being written in early-March, the stock market has tumbled over the past several months impacting upon those who live off such investments. Five unknown factors that could impact upon holding Oahu real estate investments are:
1. Will your wants and needs change over time? We found that we stopped using our condo after our house was remodeled; i.e., we no longer had a need to escape to a hideaway. Are you holding on to real estate that has lost its utility to you as a future home?
2. What if the nation enters a lengthy recession or if Hawaii experiences another decade like the 1990’s when the state economy tanked and housing prices nose-dived? A terrorist attack or an avian flu epidemic could devastate our tourist-driven economy.
3. Our housing market is interest-rate dependent. For a number of years we’ve enjoyed low rates; however, they will eventually increase which will impact negatively upon the market.
4. Unexpected expenses are always a potential problem owning real estate. How likely is a roof replacement or a large special assessment or significant increase in maintenance fees?
5. The federal capital gains tax rate is relatively low at only 15%; will this increase in the future? Sen. Obama has already gone on record supporting an increase from 15% to 28%. How likely is an increase also in the Hawaii capital gains tax rate?
Option #1 Continue to Hold Until Prices Increase: We had a mortgage on the condo as well as a relatively high maintenance fee, so this was a costly option. We viewed owning the condo as a substitute for an annual vacation. In retrospect, we should have sold it earlier at the top of the market; however, we didn’t really know or project that we weren’t going to continue to use it. In fact, just the opposite occurred; we kept projecting we would begin to use it again in the near future. And, then one day we got an offer and were forced to become objective and realize that it had become a financial drain with limited utility.
Option #2 Rent Until Prices Increase: This option made good economic sense and penciled out very well. The rent would cover our monthly outflow. Plus, we could conduct a 1031 exchange when we sold deferring both federal and state capital gains taxes. The downside is my wife and I are both 75 years old and would be exchanging the property for more real estate in about ten years or when we were both 85 years old. We viewed this option as estate planning for our heirs.
Option #3 Rent to Qualify for a 1031 Exchange & Sell: You don’t have to rent property to justify that it is being held for investment purposes, an obvious example being vacant land. However, the onus is on the exchanger to show it is or was being held for investment purposes. Showing rent is a very easy method to document an investment, particularly if it has been rented for at least a year at a fair market rent with a tax return having been submitted to the IRS documenting the rental income. There are no time requirements in the regulations for renting a property; however, most experts support the year-plus-a-day criteria. The key to this option in comparison to #2 is the return we could have achieved on another investment versus continuing to own the condo. In our case, we had sufficient equity that it would have made far better economic sense to invest elsewhere; e.g., sell and buy two condos vice just owning one. The downside is that we would have lost our $500,000 sale and had rental wear & tear.
Option #4 Sell Now & Conduct a 1031 Exchange Without Renting: We moved back into our new house the end of 2005 with the condo having very limited use by us in 2006 and 2007. We could have made the case that it had become investment property being held solely for appreciation, admittedly a very weak position that I wouldn’t have wanted to have to defend in an IRS audit. The benefit is we would have kept the $500,000 sales price and could have conducted a 1031 exchange without the wear & tear of renting the property for at least a year.
Option #5 Sell Later & Conduct a 1031 Exchange Without Renting: In this option we also don’t actually rent the condo; however, we keep it on the market at a high rent to discourage applications and/or make improvements to it over a period of time to enhance its value and have it qualify as investment real estate. Then, we sell it. This one would have lost our $500,000 sale. And, it wasn’t too applicable to us, as we had already totally upgraded the condo. However, exchangers do this sometimes accepting the risk that their exchange may be disallowed. The benefit is their property doesn’t have the wear & tear of being rented; plus, it is still available for their personal use while making improvements.
Option #6 Actually Shift Our Primary Residence to the Condo: This may have been the best of all the options from a financial viewpoint. It would eliminate the need to purchase replacement real estate via a 1031 exchange and would enable us to exclude up to $500,000 of gain (married). The downside is we would have to occupy the one bedroom condo for two years. There are a myriad of reasons why this wasn’t practical for us particularly with a newly, remodeled house, large dogs, etc.
Option #7 Claim a Shift of Primary Residence to the Condo: You have to occupy a primary residence for two out of five years to qualify for an exclusion; however, you don’t need to actually have lived in it for two full years; e.g., an owner that alternates living in Hawaii and on the Mainland with their primary residence being on the Mainland, doesn’t change their primary residence while they are in Hawaii. Under this option, you change your mailing address, voting registration, etc. to the condo, and alternate living between the house and condo. Since most of our furniture, clothes, personal belongings, etc. would be maintained in our Kailua house, it would be difficult to justify that a relatively small condo had become the primary residence for us compared to a much larger, far more comfortable, newly remodeled house in the same city. This option borders on fraud and is way outside our comfort zone. However, if your properties were in two different cities/states, it might make sense.
Option #8 The Divorce Option: This is similar to #6 and #7, however, only one spouse moves to the condo. Either my wife or I could have divided our time between living in our house and the condo with one of us declaring the condo as a primary residence for a $250,000 vice a $500,000 exclusion. I have titled this one as the “Divorce Option.”
Option #9 Use the Property as a Vacation Home: I didn’t know about this until I heard about Revenue Procedure 2008-16, refer to the next page (page #5). It wouldn’t have been practical for us, as family members used our condo and we never rented it. However, this option could work if there were advanced planning. Put a tenant in for at least 14 days during each of the two 12-month periods and restrict personal use to no more than 14 days or 10% of the rented period. You might get additional usage by working on/improving the condo.
Option #10 Sell, Pay the Taxes & Run: This became our choice. At age 75, my wife and I prefer cash or liquid assets to owning investment real estate; i.e., in our personal life we have become ardent supporters of the “bird-in-hand” perspective. We closed on the condo in January 2008 vice late-2007 to postpone paying the capital gains taxes for a year.
Last But Related: The option many absentee owners face when selling Oahu property is whether they should conduct a 1031 exchange, deferring capital gains taxes but having to purchase replacement real estate, usually on the Mainland. Or, would it be better for them to pay the taxes and not be involved in having to purchase more real estate? There are a number of variables that influence this decision such as the amount of taxes, the equity in the property, the age(s) of the owner(s) and their health, their short and long-range financial objectives, etc. Over the past ten years, I have discussed this topic about 300 times with absentee owners. There seem to be some very definite trends. If you are interested in discussing this or any of the options, call me toll-free at: 1-800-922-6811.
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Ten Selling Options for a Hideaway
Click here to view the entire newsletter.
Background: In the last newsletter, I discussed a one bedroom, condo my wife, Mary Lou, and I owned as a Waikiki hideaway. In December 2006, we appealed the assessed value for taxes for the condo. Our appeal was rejected in November 2007; however, it worked out to our benefit, as someone who had heard about our unit appeared out of the blue and offered to purchase it even though it was not listed for sale. Our high-assessed value for taxes was useful in supporting a counter offer by us on price. In this section of the newsletter, I’ll discuss the various options available to us.
NOTE: The Stott Team is not licensed to provide either tax or legal advice. Licensed professionals such as attorneys or CPA’s should be consulted for such advice.
We had owned a condo in Waikiki for about ten years, first a studio unit with a golf course view in Fairway Villa and then a one-bedroom unit with a spectacular ocean view in Aloha Towers. A typical Saturday would often find the two of us attending a movie in Honolulu in the afternoon, then a short drive to our condo, walk to one of a number of nearby restaurants for dinner, spend Saturday night at the condo and return to our house Sunday morning.
In 2005, we gutted and completely remodeled the Kailua Beachfront house that had been a home to us since 1977. During the remodeling, we put most of our furniture, personal affects, etc. into storage and moved into the one-bedroom Aloha Tower unit for about ten months. After ten months of actually living in Waikiki and with a completely remodeled house, we found that going to our small hideaway had lost much of its charm. The unexpected offer forced us to make a decision we should have seriously considered a year or two earlier
This article was developed from my January & February 2008 E-Mail Updates. In them, I explained that we had sold the unit and outlined some of the options available to us. This was then followed by a series of e-mails with several of the recipients discussing various options. This newsletter goes to several attorneys/CPA’s as well as to some very experienced investors/realtors. If any of you know of options I’ve overlooked, please advise me. For space considerations, I have deliberately omitted various tax saving/deferment techniques such as an installment sale or establishing a charitable remainder trust.
For about two years, Paul Brewbaker, the Chief Economist for the Bank of Hawaii has maintained that the next period of rising prices on Oahu will begin sometime in the 20-teens, refer to page #8 of the newsletter. Using the middle of the 20-teens or 2016 as the start of rising prices and a 2-year rise until the market peaks, we would be selling our condo in about 10 years if we had decided to hold on to the unit to maximize the sales price.
Our condo unit had been totally upgraded by us about five years prior to the sale with all new appliances, cabinets, countertops, furniture, carpeting, tile, etc. We sold it fully furnished in turnkey condition. Included was artwork as well as a large HDTV. The sales price was an excellent $500,000. If we had rented it for a year to have it qualify as investment real estate, it is unlikely we could have found another motivated buyer wiling to pay anywhere near that price in our slumping housing market; moreover, there would have been rental wear & tear.
If we had waited for the next soaring housing market to sell; i.e., 10 years, an increase in value of 30% to 40% might be reasonable based upon historical Oahu housing markets. This would correlate to an increase in value of $150,000 to $200,000. From an investment viewpoint, would it be better to take our equity and invest it elsewhere or wait for the next soaring market?
Five Unknown Factors: With any investment, there are unknown factors that can impact upon the results of your decisions. As this is being written in early-March, the stock market has tumbled over the past several months impacting upon those who live off such investments. Five unknown factors that could impact upon holding Oahu real estate investments are:
1. Will your wants and needs change over time? We found that we stopped using our condo after our house was remodeled; i.e., we no longer had a need to escape to a hideaway. Are you holding on to real estate that has lost its utility to you as a future home?
2. What if the nation enters a lengthy recession or if Hawaii experiences another decade like the 1990’s when the state economy tanked and housing prices nose-dived? A terrorist attack or an avian flu epidemic could devastate our tourist-driven economy.
3. Our housing market is interest-rate dependent. For a number of years we’ve enjoyed low rates; however, they will eventually increase which will impact negatively upon the market.
4. Unexpected expenses are always a potential problem owning real estate. How likely is a roof replacement or a large special assessment or significant increase in maintenance fees?
5. The federal capital gains tax rate is relatively low at only 15%; will this increase in the future? Sen. Obama has already gone on record supporting an increase from 15% to 28%. How likely is an increase also in the Hawaii capital gains tax rate?
Option #1 Continue to Hold Until Prices Increase: We had a mortgage on the condo as well as a relatively high maintenance fee, so this was a costly option. We viewed owning the condo as a substitute for an annual vacation. In retrospect, we should have sold it earlier at the top of the market; however, we didn’t really know or project that we weren’t going to continue to use it. In fact, just the opposite occurred; we kept projecting we would begin to use it again in the near future. And, then one day we got an offer and were forced to become objective and realize that it had become a financial drain with limited utility.
Option #2 Rent Until Prices Increase: This option made good economic sense and penciled out very well. The rent would cover our monthly outflow. Plus, we could conduct a 1031 exchange when we sold deferring both federal and state capital gains taxes. The downside is my wife and I are both 75 years old and would be exchanging the property for more real estate in about ten years or when we were both 85 years old. We viewed this option as estate planning for our heirs.
Option #3 Rent to Qualify for a 1031 Exchange & Sell: You don’t have to rent property to justify that it is being held for investment purposes, an obvious example being vacant land. However, the onus is on the exchanger to show it is or was being held for investment purposes. Showing rent is a very easy method to document an investment, particularly if it has been rented for at least a year at a fair market rent with a tax return having been submitted to the IRS documenting the rental income. There are no time requirements in the regulations for renting a property; however, most experts support the year-plus-a-day criteria. The key to this option in comparison to #2 is the return we could have achieved on another investment versus continuing to own the condo. In our case, we had sufficient equity that it would have made far better economic sense to invest elsewhere; e.g., sell and buy two condos vice just owning one. The downside is that we would have lost our $500,000 sale and had rental wear & tear.
Option #4 Sell Now & Conduct a 1031 Exchange Without Renting: We moved back into our new house the end of 2005 with the condo having very limited use by us in 2006 and 2007. We could have made the case that it had become investment property being held solely for appreciation, admittedly a very weak position that I wouldn’t have wanted to have to defend in an IRS audit. The benefit is we would have kept the $500,000 sales price and could have conducted a 1031 exchange without the wear & tear of renting the property for at least a year.
Option #5 Sell Later & Conduct a 1031 Exchange Without Renting: In this option we also don’t actually rent the condo; however, we keep it on the market at a high rent to discourage applications and/or make improvements to it over a period of time to enhance its value and have it qualify as investment real estate. Then, we sell it. This one would have lost our $500,000 sale. And, it wasn’t too applicable to us, as we had already totally upgraded the condo. However, exchangers do this sometimes accepting the risk that their exchange may be disallowed. The benefit is their property doesn’t have the wear & tear of being rented; plus, it is still available for their personal use while making improvements.
Option #6 Actually Shift Our Primary Residence to the Condo: This may have been the best of all the options from a financial viewpoint. It would eliminate the need to purchase replacement real estate via a 1031 exchange and would enable us to exclude up to $500,000 of gain (married). The downside is we would have to occupy the one bedroom condo for two years. There are a myriad of reasons why this wasn’t practical for us particularly with a newly, remodeled house, large dogs, etc.
Option #7 Claim a Shift of Primary Residence to the Condo: You have to occupy a primary residence for two out of five years to qualify for an exclusion; however, you don’t need to actually have lived in it for two full years; e.g., an owner that alternates living in Hawaii and on the Mainland with their primary residence being on the Mainland, doesn’t change their primary residence while they are in Hawaii. Under this option, you change your mailing address, voting registration, etc. to the condo, and alternate living between the house and condo. Since most of our furniture, clothes, personal belongings, etc. would be maintained in our Kailua house, it would be difficult to justify that a relatively small condo had become the primary residence for us compared to a much larger, far more comfortable, newly remodeled house in the same city. This option borders on fraud and is way outside our comfort zone. However, if your properties were in two different cities/states, it might make sense.
Option #8 The Divorce Option: This is similar to #6 and #7, however, only one spouse moves to the condo. Either my wife or I could have divided our time between living in our house and the condo with one of us declaring the condo as a primary residence for a $250,000 vice a $500,000 exclusion. I have titled this one as the “Divorce Option.”
Option #9 Use the Property as a Vacation Home: I didn’t know about this until I heard about Revenue Procedure 2008-16, refer to the next page (page #5). It wouldn’t have been practical for us, as family members used our condo and we never rented it. However, this option could work if there were advanced planning. Put a tenant in for at least 14 days during each of the two 12-month periods and restrict personal use to no more than 14 days or 10% of the rented period. You might get additional usage by working on/improving the condo.
Option #10 Sell, Pay the Taxes & Run: This became our choice. At age 75, my wife and I prefer cash or liquid assets to owning investment real estate; i.e., in our personal life we have become ardent supporters of the “bird-in-hand” perspective. We closed on the condo in January 2008 vice late-2007 to postpone paying the capital gains taxes for a year.
Last But Related: The option many absentee owners face when selling Oahu property is whether they should conduct a 1031 exchange, deferring capital gains taxes but having to purchase replacement real estate, usually on the Mainland. Or, would it be better for them to pay the taxes and not be involved in having to purchase more real estate? There are a number of variables that influence this decision such as the amount of taxes, the equity in the property, the age(s) of the owner(s) and their health, their short and long-range financial objectives, etc. Over the past ten years, I have discussed this topic about 300 times with absentee owners. There seem to be some very definite trends. If you are interested in discussing this or any of the options, call me toll-free at: 1-800-922-6811.
Back to Useful Newsletter Articles