You really should talk to your CPA. If you have any equity (above your purchase price) in your home you can sell it and not pay any taxes on that equity as long as you have lived in 2 of the last 5 years. If you turn it into rental property longer than that you may have to pay taxes.
Talk with a CPA regarding the tax implications of:
This year's taxes
Also check about insurance. Most policies do not cover vacant property (unoccupied for more than 30 days)
Tax implications when you decide to sell - laws have recently changed.
You should consult the accountant you use on an annual basis to review and advise on your situation. If you are used to preparing your own tax return, you should consider paying a tax professional a few hundred dollars to advise you and prepare your 2009 return.
Here are a couple things to think about with regard to your second property:
1. You will still get the benefit of a tax deduction for the Mortgage Interest and Property Taxes.
2. If you turn it into a rental property, you will be able to take a sizeable deduction for Depreciation.
3. If you keep good records for all the income and expenses while renting out the property... and should you take a loss, you will be able to claim that on your return.
4. Homestead Exemption is typically only available on primary residences.
From the picture you paint, it sounds like Renting or Lease-Optioning your property is the best scenario. You will be able to generate some cash flow and take advantage of some tax advantages while allowing the market to recover and potentially making the property more valuable down the road... seems like a much better scenario than forking out money each month to carry the property. If you decide to go this route, you need to be savvy when pre-approving tenants and managing the rental process. Feel free to call me should you need any assistance in this process.
Also, check with an accountant regarding renting. That's actually not a bad idea at all. It brings in cash and buys time to allow the market to recover further.
You might also consider offering the house as a lease-option. That might get someone in there right away paying slightly than higher market rent, as well as finding a prospective buyer for you. There are some risks with lease-options, though they're largely on the tenant-buyer's side, not yours. And, honestly, most real estate agents don't like them because the commission on the sale occurs only when/if the property sells.
Still: Look into lease-options. And check with an accountant now.
Hope that helps.
Housed - I've lived in Kirkwood since 2004 - my expertise is focused in this area - if you want a second opinion and some marketing ideas, or just some help forecasting what to do, please call me...