When Maj. Paul J. Hesse, USAF-Ret., found himself manhandling scores of garbage bags containing the remaining possessions of former renters he had evicted from his family home, he began to rethink his decisions of the last few years. It had seemed a good idea to hold onto the house, located just north of Cincinnati, when Hesse received permanent change of station orders for a base 1,500 miles away. For two years, he had good tenants — the kind who pay their rent on time and take care of their rented home as if it were their own. But then he hired a local real estate agent in 2002 to serve as property manager for new tenants. Not only did Hesse’s new renters turn out to be just the opposite of the ideal tenants who lived in his home the first time, but the property manager didn’t do his job. He failed to enforce the terms of the lease agreement, and when things spiraled out of control, he failed to evict the negligent tenants.
 
Despite that bad experience, Hesse says he is glad he held on to the Cincinnati-area property. As he prepares to retire in the home, he offers this perspective on long-distance home ownership: “Both my successes and failures came down to whether or not I did my homework [and] whether I was managing it myself or having someone else do it. It’s not about managing property, but about managing people.”

Dollars and sense

One of the first decisions you will have to make when owning a home long distance is whether to manage it yourself (with the help of friends or family members in the area where the home is located) or to hire a professional property manager. Paying 10 percent of the rent to a property manager can be a worthwhile and reasonable expense. But, be sure to factor in a deposit for repairs that some companies require, which costs even more. Given the expense, you want to be sure you’ve hired a reputable manager or management company.

Maj. Russ Perkins, USA, currently owns two rental properties. He manages one himself, with the help of a friend near the rental home, and the other is managed by a professional company. “You have to use your own personal calculus to determine which option makes sense for you at that time and in that specific circumstance. In our first experience as landlords, we were unhappy with our management company and had to find another, which proved difficult and costly. We chose to act as property managers on our second home, which can have its own set of challenges. We now have to deal with tenants ourselves, advertise the property, and come up with our own lease,” says Perkins.

Former Army Capt. Phil Dyer, MOAA’s deputy director for financial planning, cites a number of other factors that can add to the cost. Unplanned vacancies and setting rental rates too low are “alligators” that slowly eat a landlord one bite at a time. Perkins recommends setting aside a minimum of six months’ mortgage payments to stave off such alligators. “We didn’t want to be in a situation where we would have to tap into our savings. But we knew inevitably there would be periods when our rental properties would be vacant or we would have unexpected repairs or expenses. So having money set aside for these situations adds to our comfort level,” says Perkins.

With the right planning, there is money to be made on residential real estate — if the property is rented out full-time, the maintenance costs are low, and you can keep the property long enough for it to appreciate. Dyer says it’s not surprising that some retired officers accumulate six to eight properties during their military career and can gain considerable equity while letting someone else make the mortgage payments.

At one time, Cmdr. Desley Parker, USN-Ret., and her husband, Capt. Brance Parker, USN-Ret., owned a primary residence and three rentals. They sold one of their rentals, too small for the retirement home they wanted, to get the cash to buy a second vacation home. “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.”

The Parkers managed the properties themselves. They liked a hands-on experience that saved money and allowed “relationship building” with tenants and continued connection with the community.

Tax facts

Renting out one or more homes can directly affect 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,” says Dyer.

Dyer and Enrolled Agent David A. Shaw, a federally licensed tax expert who served in the Air Force, give the following 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 always will be depreciated (allowed or allowable by the IRS, 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 phaseout when AGI is between $100,000 and $150,000,” says Shaw. He also cautions that not all repairs or improvements are fully deductible the year of the expense and might be subject to state laws that could 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 also the state in which the property is located as well.” Two state returns might be necessary for those 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, reconvert 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 percent 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 to the rules that apply to depreciable assets.”
   
• Passive or nonpassive? “If you manage the rental property yourself, that is considered active participation. So in this situation, any loss you incur up to $25,000 per year can be used to offset normal income,” says Shaw. “If you have a management company in charge, you have a passive role, which means you have passive income or loss. A loss from a passive activity can only be used to offset other passive income, such as another rental property or portfolio income. It could not be used to offset normal income such as retired military pay.”

Snowbird issues

Dyer says snowbirds — those who legitimately spend equal time each year in two locations — can choose one location (usually the one with the best tax structure, such as Florida or Texas) as their 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, because most part-year resident tax laws only applied to earned income, not retirement or 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. Make sure you have a strong position that the nontaxable state ... is your true domicile.”

Some snowbirds skirt the whole distance issue by owning recreational vehicles, which usually qualify as second residences. For instance, Tech. Sgt. Arnold L. Payne, USAF-Ret., and his wife, Mary Ann, can “go anywhere we want,” says Mary Ann. The maintenance issues of their primary home in Lynnewood, Wash., are handled by their daughter, while their “vacation home” is located anywhere its wheels will take it, complete with a new picture-window view every day if they wish.

To any aspiring long-distance landlords, Perkins offers this as his most valuable advice: “Your best resource is your military family. There are so many of us who have learned from our mistakes and come out successful.”