RetireJapan

Hi everyone,

I know that this category is mostly used by people who wish to buy a mansion but I am coming from a different angle. I do not think the subject was mentioned before on this forum. I have purchased my mansion 3 years ago for several reasons.
Unfortunately, for family reasons I may have to head back to Europe. I do not know if this is going to be for a short or long time, neither temporary or permanent. The mansion I have is well located and very convenient. I would prefer to keep it which means I rent it and if I come back to Japan I can take it back for myself. The problem with that is since the house is on a flat 35 loan I have to switch to an investment loan with a higher interest rate. Also, since the value of houses in Japan tend to decrease and prices are higher compared to when I purchased, selling is then the other alternative.

I was wondering if anybody has faced the same dilemma and if you have advice to provide or a different way on how I should look at that problem.

Thanks in advance. Always appreciated.

I ran some numbers for our manshon for when we move out (expecting to inherit my wife's parents' place at some point).

For us, the market rent barely covered the mortgage/manshon fees/real estate management company fees. It made almost no sense to rent it out instead of sell it, especially as the prices have gone up a lot for units in our building.

Your numbers might be different though!

This will be a funky one to run the numbers on.
You will not be a Japan tax resident anymore so the tax part of the equation cannot be covered by your standard real estate agent in Japan.
Being away you will also have to pay an agency to manage the property on your behalf.

I would go to one of the big real estate company like Tokyu and see if they can share some numbers with you.
Don't tell them that you want to sell and that you are moving out of the country.
Then ask another agency to run the numbers on selling your place.

If you can, I would not trust their result but take the input data they give you (expected rent, expected sales price, fees etc.) and do an excel model yourself. try to account for the tax to the best of your knowledge. Then eventually pay a tax specialist if the numbers are close.

Personal experience for me, with a mansion in Tokyo, was that the rental market was a good option - rent more than covers the mortgage and I think the place is holding its value, and possibly even appreciating, contrary to received wisdom. That said, the tenants are on a fixed term contract so there would be a lot of issues if I suddenly decided to move back in. As it stands though, I am glad I kept the apartment. I've not had to change anything on my mortgage and the mortgage provider didn't bat an eyelid when I went through the change of address procedure.

There are a lot of moving parts. Let me see if I can remember them all...

Sale:
As it is right now, if you have only owned the property for 3 years (less than 5 years), any Capital Gain after Fees and Expenses would be taxed at the punitive Short-Term Capital Gains Tax Rate of 30% National, 0.63% Reconstruction and 10% Residents Taxes = Total 40.63% (double the Long-Term Capital Gains Tax Rate), and you would not be entitled to the Capital Gain Primary Residence Tax Deduction or Capital Loss Carry-Over provisions.

Rental:
If your mansion is from one of the big developers, they may have a Management department that can manage it for you while you are away, or you can seek other Management Companies. The rate will probably be around 15% of the Annual Rental Income. To distinguish this from the Property Management Fee that you currently pay, for Services and Repairs, etc., I will call this 'Rental Management'.

Depending on Location, your Gross Return (Rimawari - 利回り) will probably in the range of 3% to 4%
i.e. your total rent per year would be somewhere around 3% or 4% of the Purchase Price or Current Property Value...

When you rent out in Tokyo, you would receive a couple of months rent up front, either for Security Deposit, Key Money, or both.
Security Deposit probably has to be returned when the tenant moves out, but Key Money was invented after the war as a way to get around Rent Controls, and it has not gone away. If you received one month's Key Money, over a 2 year contract, it's like increasing the Rent by 1/24 or 4.16%, so you can potentially charge a slightly higher rent if you waive the Key Money... Or you may have to negotiate it away, so maybe start a little high...

You have to tell your lender that you are going to rent out the property. They may raise your Interest Rate as a Rental instead of your primary residence.
When you rent the property out, you loose your current Annual Loan Tax Deduction.
The tenant pays the Property Management Fee that you currently pay for services and repairs, etc.. This is not considered income to you.
In the early years, the Rent will probably just cover your Mortgage Payment and Rental Management Fee. It may be only slightly cash-flow positive, or even slightly cash-flow negative... i.e. you may have to pay a small amount out of pocket each month.
That is not entirely true... Technically, you are actually using all of the Free Cashflow after paying all Operating Expenses (which includes Interest on the Debt, but not the Debt itself), and maybe a little extra out of pocket, to pay down the Debt.

However, that does not mean that it is a bad investment.

You may be able to raise the rent when contracts are renewed or the tenant changes in the future, depending on Inflation. There are costs when the tenant changes, such as cleaning and redecorating. These may be partially covered by withholding some or all of the Security Deposit, depending on the state of the property, and are deductible.

The Rent includes the Loan Interest Portion, which is deductible as an expense, and is therefore not subject to Tax.
Your Rental Management Fee (Maybe 15% of the total Annual Rent) is also deductible as an expense, and is therefore not subject to Tax.
Fixed Asset Tax (Kotei Shisan Zei) is also deductible.
Only the remaining amount (Principle Repayment portion), which is relatively small portion of your total payment in the early years, is income and therefore taxable.
However, if you want to, you can claim depreciation as an expense and offset the income.

Depreciation:
Instead of the Annual Loan Tax Deduction on Primary Residence, you can claim Depreciation as an expense for rental properties.

If you bought the property New (first owner), then a portion of the total payment was for Consumption Tax (Shohizei) on the portion of the price for building and Fixtures and Fittings. See below. this does not come back, and is not deductable or depreciable.
When you bought the property, a certain portion of the purchase price was probably for your portion of the land. This is not depreciable.
A certain portion of the purchase price was for the building structure and fixtures and fittings. If you want to, you can claim depreciation on this value.
If the structure is a Steel Re-inforced Concrete Structure, the depreciation would be over 47 years according to the Japanese Accounting Standards, so you can claim 1/47 th. of this building structure purchase price as a Depreciation Expense, except for...
A certain portion of the building structure purchase price was for the internal fixtures and fittings (bathroom, kitchen, flooring, etc.) and this portion can be depreciated over 15 years according to the Japanese Accounting Standards, so you can claim 1/15 th. of this internal fixtures and fittings price as a Depreciation Expense.

These expenses can offset the income from the rent, and so potentially, you can end up paying little or no tax. Probably, the Depreciation on Fixtures and Fittings would be enough to offset the income tax.

If you were in Japan, but the property was still rented out (so you were living somewhere else), you could also use the Depreciation Expense against your employment income, instead of the Annual Loan Tax Deduction, and reduce your Income Tax at your marginal tax rate. You would save not only National, Reconstruction and Residents' Taxes, but also reduce other expenses such as medical insurance that are calculated according to your taxable income.

However, if you do claim the depreciation as an expense, the Tax Basis goes down from the purchase price by that amount, and so you would have to pay additional Capital Gains Tax on that amount when you come to sell the property. But, the Long-Term Capital Gains Tax (National 15%, Reconstruction 0.315% and Residents' Taxes 5% = Total 20.315%) would be lower than the tax and other expenses you saved, so would still be a net benefit to you.

This may not benefit you if you are not in Japan, and so you may not want to use the Depreciation Expense.

If you were to move back in to the property when you return to Japan, you would be moving into a property that has been paying for itself while you have been away, and if you were to then sell, you would take advantage of the Primary Residence Tax Deduction, currently Y30M, when you sell.

Investment Gain

The Property Value may go down, as the property is depreciated, may stay about the same, if the land price appreciates about equal to the depreciation, or may even rise in value in the future. There are some locations where property prices have been going up quite nicely.

Assuming you made a down-payment of say 10% when you bought the property, you will have paid down the mortgage for the years that the property was rented out, and the outstanding balance of a 35 year loan will reduce faster than the depreciation.

If you kept the property for say 10 years, and were able to sell it for roughly what you paid for it, your outstanding balance of the loan would have probably reduced by about 20% (depending on loan length, interest rate, repayments, etc.), giving you about 30% total equity in the property (Your initial 10% Deposit and the 20% reduction in the outstanding balance of your loan). After paying off the loan and other costs, you'd be left with about 30%. That's a 200% absolute return on your 10% down-payment or an annual growth rate of about 11.5% per year, ignoring any additional monthly inputs you had to make. (Much higher than the gross Rimawari that I stated at the beginning, due to the use of leverage in the form of the Mortgage).

If you kept the property for say 20 years, and were able to sell it for roughly what you paid for it, your outstanding balance of the loan would have probably reduced by about 45% (depending on loan length, interest rate, repayments, etc.), giving you about 55% equity in the property (Your initial 10% Deposit and the 45% reduction in the outstanding balance of your loan). After paying off the loan and other costs, you'd be left with about 55%. That's a 450% absolute return on your 10% down-payment or an annual growth rate of about 8.9% per year. (Still higher than the gross Rimawari that I stated at the beginning due to the use of leverage in the form of the Mortgage).

But if the property hasn't actually gone up in value, and you haven't actually used the depreciation expense, the Tax Basis would be the Purchase Price, so you would have no actual Capital Gain, so that money left after paying off the Loan would be Tax Free.

If you have used the depreciation expense, then your Tax Basis will have gone down from the purchase price by the total amount of depreciation claimed, and so you'd have to pay Capital Gains Tax on the difference between the Tax Basis and the Sale proceeds after all transaction fees, i.e. roughly the amount of depreciation you had claimed over the years...

If the property has actually gone up in value, you'd have to pay Capital Gains Tax on the difference between the Tax Basis and the Sale proceeds after all transaction fees.

If, as I said earlier, the property is your primary residence at the time when you sell, you get a big Primary Residence Tax Deduction, currently Y30M, if you have held the property for more than 5 years, again reducing the taxable gain, maybe to zero...

If you make a Capital Loss on selling a Primary Residence that you have owned for more than 5 years, the loss can be carried over for up to 3 years and can be deducted from other qualifying income under certain conditions.

And of course, this will have been funded in large part by the tenant.

If you don't sell, you'll be that much closer to owning the property free and clear of the Mortgage, and then you'll only have to pay the Property Management Fee and the Fixed Asset Tax (Kotei Shisan Zei) in retirement.

If you renewed the Bathroom, Kitchen, Fixtures and Fittings, after 15 or 20 years, or when you came back to Japan, you can add those costs to the Tax Basis for future Capital Gain calculations.

You would have to appoint a Tax representative while you are not in Japan.

This is only an illustration, and actual results may differ considerably from the rough example given above.

Any corrections? Anyone?

eagleyes wrote: ↑Fri Jul 22, 2022 7:30 am... I would prefer to keep it which means I rent it and if I come back to Japan I can take it back for myself. The problem with that is ...

One problem with that not yet mentioned is that your tenant has certain rights to stay--you can't just say 'leave', or not renew and expect that to happen.

It might, but there are also questions posted by renters who say their landlord has asked them to leave (maybe they're selling the unit, or the building is going to be demolished and rebuilt).

The advice for the renters in this case is to try to get as much compensation as possible from the landlord. And IIRC, it's usually six months of rent being returned to the renter and the landlord also covers the cost of the move.

Something to budget for when renting.

Thanks for your replies. Yeah so I think I need to go back to the excel white board and plug in the numbers.
Having say that, if there is not a big difference I think it will come back to my intuition or what I feel more comfortable with to manage.
I completely forget about the 5 year rule on capital gains. This is a major point.