How To Sell A Rental Property [And Save On Taxes]
As professional real estate consultants, we understand that real estate investment is a proven avenue for financial growth. The focus often shifts from whether you’ll make money to determining the speed and magnitude of your return on investment.
Converting your property into a rental stands out as an excellent strategy for generating passive income and steadily building long-term wealth. The consistent cash flow from rental payments not only complements your regular income, especially if you’re still employed, but also provides the security of real estate ownership.
However, life can present unexpected challenges, prompting the need to divest your rental property. Whether it’s to settle debts, cover medical bills, or due to the escalating property taxes making ownership less lucrative, there are instances where selling becomes a prudent choice.
Navigating the decision to sell a rental property can be complex, and that’s where our comprehensive guide comes in. We’re here to lead you through the entire selling process, ensuring minimal tax impact and maximizing the cash you take away from the sale. Trust us to help you make informed decisions for your financial benefit.
SIGN IT’S TIME TO SELL A RENTAL PROPERTY
According to the National Association of Realtors, the median price of property sold in 2012 was just $154,700. Now as of 2024, the median home price is $390,000! Today might be a good time to cash in your gains, as no one knows how long real estate prices will remain this high.
Housing Demand Vastly Exceeds Supply
In today’s real estate landscape, the demand for housing far surpasses the available supply. Seize this opportunity to capitalize on the current momentum, recognizing that theses favorable market conditions could change at a moment’s notice.
Changing Local Market Conditions
Keep a close eye on the local market conditions, especially if growth and job opportunities in the town where your rental property is situated are dwindling. A slowdown in these aspects may result in a scarcity of tenants, leaving your investment property unoccupied. In such scenarios, it might be prudent to explore selling and redirecting your investment elsewhere. For detailed insights into market conditions, consult with a local real estate agent.
Rental Property Needs Repairs
If your rental property requires significant and costly repairs, such as foundation issues or septic system failures, selling may be a more practical choice than investing more money in its upkeep. Many real estate investors actively seek distressed properties, making it feasible to sell a property with existing problems without encountering difficulties.
Rental Property is Inherited Property
In the event of inheriting a rental property, especially if you reside out of state or find yourself unsuited for the role of a landlord, selling the inherited property could be a viable option. Opting to cash out allows you to realize the gains from the inherited property and frees you from the responsibilities associated with managing it.
You Want to Retire from Being a Landlord
Property management is not universally appealing, and signs of weariness, whether from rent collection, tenant interactions, or property maintenance, may indicate that it’s time to consider other opportunities. If you find yourself wanting to retire from the role of a landlord, exploring the option to sell could open doors to new ventures.
How To Have A Smooth Rental Property Sale
Know Your Target Buyer
Before delving into the selling process, identify the type of buyer you prefer for your rental property. Whether targeting real estate investors, first-time homebuyers, or existing tenants, understanding their expectations guides your marketing strategy, pricing decisions, and considerations for current tenants.
Conducting a Pre-listing Home Inspection
To secure the best price for your rental property, arrange a pre-listing home inspection. A thorough examination by a professional inspector reveals necessary repairs, ensuring your property is in top condition for listing. This step enhances the property’s appeal and increases its market value.
Assessing Repairs or Selling As-Is
Deciding whether to invest in repairs or sell your rental property as-is requires careful consideration. A well-maintained property often commands a higher asking price, but the upfront investment may not be feasible. Alternatively, selling as-is to a real estate investor, who is typically a cash buyer, can expedite the sale process, especially if the property has suffered neglect.
Performing a Lien Search
Before listing your rental property, conduct a lien search with the assistance of an escrow officer. Identifying any encumbrances allows you to address them proactively, facilitating a seamless real estate transaction.
Inform Your Tenant
Prioritize communication with your tenants about your intention to sell, offering them sufficient time to relocate. Consider providing incentives for a smooth transition, adhering to state rules, particularly in light of COVID-19 regulations affecting tenant notices.
Understanding Tax Implications
Selling a rental property involves understanding and addressing tax implications. Depreciation recapture tax and capital gains tax obligations vary based on ownership duration. Proper comprehension of these taxes is essential, and potential workarounds can be explored to minimize tax burdens.
Example of Tax Consequences
Consider an example where a rental property purchased for $80,000 is sold for $120,000 after claiming $10,000 in depreciation over five years. Assuming a 25% depreciation recapture tax rate and a 20% capital gains tax rate, the resulting tax bill is $10,500. Note that individual circumstances may differ, necessitating consultation with a tax professional or real estate attorney for personalized advice.
Options To Reduce Your Tax Burden When Selling A Rental Property
A 1031 exchange is like a special tax break named after a rule in the tax code. It helps you delay paying taxes when you sell a rental property. Here are the important rules:
1. **Use for Business or Investment:** You can only do a 1031 exchange if you want to buy property for your business or as an investment.
2. **Buy Something Similar or More Expensive:** The new property you buy must be worth the same or more than the one you sold.
3. **Time Limits:** After you sell your property, you have 45 days to find a new one and 180 days to finish buying it.
Doing a 1031 exchange has cool benefits. One big advantage is that you can use the money from selling a property in an expensive place, like California, to buy more properties in a cheaper place, like Utah. It’s like getting a chance to grow your real estate investments in different areas.
Consider Living in your rental prior to selling in order to avoid capital gains tax
When selling your main home, you can avoid paying taxes on a profit of up to $500,000 (if filing jointly with your spouse) or $250,000 (if filing singly). To qualify for this tax benefit under the Taxpayer’s Relief Act of 1997, you need to pass the Internal Revenue Service (IRS) ownership test, which includes:
- – Own the home for at least two years.
- – Follow the 2-in-5 year rule: live in the property for two or more years within the five years before selling.
Selling your home as a personal residence instead of just as a rental property is more tax-friendly. However, it’s essential to note that selling your primary residence doesn’t qualify for a 1031 deferred exchange.
Maximizing Property Appeal through Tax-Deductible Repairs
Undertaking repairs on your property not only enhances its attractiveness to potential buyers but can also open up opportunities for tax deductions. It’s important to note, however, that these deductions apply only to repairs aimed at maintaining the property’s good working condition, not those meant to add value.
Consult with a Tax Professional for In-Depth Guidance*
To fully understand the intricacies of tax-deductible repairs, it is advisable to seek advice from a tax professional. They can provide comprehensive insights tailored to your specific situation.
Tax Harvesting: Leveraging Losses to Offset Gains
Not all properties in an investor’s portfolio yield positive results. When faced with underperforming properties, it may be necessary to consider realizing losses. This strategy, known as tax harvesting, involves evaluating the property for potential tax-deductible repairs.
*Offsetting Capital Gains with Realized Losses*
In instances where you have both gains and losses in the same tax year, you can use the realized loss to offset the capital gains from another property you are selling. For instance, if you have a rental property with a negative equity of $35,000 and another property with a $60,000 capital gain, utilizing tax harvesting would result in a reduced taxable capital gain of only $25,000.
Selling A Rental Property With A Tenant
1. Streamline the Sale of Tenant-Occupied Properties with Early Termination Clauses
Selling a property with tenants becomes more manageable when an early termination clause is present in the lease agreement. Below are the grounds on which the current lease can be terminated:
- – The tenant fails to honor the terms of the lease.
- – Gross neglect of the property by the tenant.
- – Repeated inability of the landlord to collect rent.
- – The landlord intends to sell the property.
*Even without an early termination clause, you have options:*
2. Waiting for Lease Expiration
If the tenant complies with the lease terms and pays rent on time, you must honor the contract and wait for the lease to expire before selling the property. This allows you to continue receiving rental income during the waiting period.
3. Selling Property to Existing Tenant
Consider offering the property to your existing tenant before listing it on the market:
– A tenant who already likes the property may choose to buy and avoid the hassle of moving.
– Direct sale eliminates the need for real estate agents and their commissions.
– Seller financing can be offered if the tenant struggles to secure traditional financing.
4. Selling Rental Property with an Active Lease
Many buyers find rental properties with an active cash flow attractive. You can sell the property with an existing lease, and the new owner can decide whether to let the lease expire or renew it.
5. Offering Tenant Incentives to Vacate
To encourage your tenant to vacate when selling, consider offering the following incentives:
- – Covering moving costs.
- – Paying the rent differential if the tenant is moving to a higher-priced nearby property.
- – Assisting with the security deposit for the new property.
- – Providing a lump sum if a substantial profit from selling the rental is anticipated.
Steps To Selling A Rental Property
After settling any tax issues and making sure your rental property is empty or you and your tenant agree on a positive solution, selling it is quite similar to selling a regular house.
1. Working with Real Estate Agents**
If your rental property is in good shape, you can team up with real estate agents to handle various tasks like staging, showing, negotiating, and closing the deal. They’ll offer advice on how to make your property more appealing, but keep in mind, this convenience comes with costs like agent commissions and expenses for repairs and renovations.
2. Selling on Your Own (For Sale By Owner)**
If you have enough time and energy, you can sell your rental property on your own. You’ll need to take charge of tasks like staging, showing, negotiating, and closing. However, if you lack experience, getting a good price might be challenging.
3. Quick and Easy: Selling to Real Estate Investors**
Selling to a real estate investor can save you time and avoid many hassles. The big advantage is that you can cash in on your property investment with minimal effort. Investors usually buy properties as-is, so you won’t have to worry about fixing it up or arranging a professional home inspection. However, be prepared to sell at a discount since investors consider potential repair costs. Despite selling below market value, you gain from a speedy sale and leave with money in your pocket. It depends on what you value more in your home sale.
In Closing: How To Sell Your Rental Property
There are several ways that you could cash in your investment while minimizing hefty capital gains tax bills and other associated expenses that could eat at your profit.
You could opt to: sell it as a primary residence; do a 1031 exchange; use tax harvesting; or perform tax-deductible repairs. Even then, selling a rental property can come with its headaches, and there are still plenty of things you have to figure out.
Here at Academy Home Buyers, our goal is to make the sales process as painless and as hassle-free as possible. We buy all kinds of properties–even rental homes that have fallen into disrepair due to deferred maintenance or neglectful tenants.
If you’re ready to put your rental property on the market, fill out the form below and we’ll give you a quick, no obligation cash offer! We can close in as fast as 7 days, and we even cover all closing costs for you!
If you’d like to talk, call us at (757) 755-5587 and we look forward to hearing from you!