Have a rental property (or two) you're thinking about selling? If your goal is a fast sale without the hassles of making repairs and paying commission, request a free CASH offer using the form below!
How to Sell Rental Property
Real estate investing is a tried and true way of making money. Often, it's less of a question about whether you'll be able to earn, but rather how fast and how much the return on your investment will be.
Turning your property into a rental is one of the best ways to have passive income to continually grow your wealth long-term. The steady cash flow from the rent can give a great boost to your regular paycheck if you're still working; not to mention the peace of mind that comes with the security of owning real estate.
In some cases though, life can throw you a curve ball and you may need to dispose of your rental property; say, you might need the cash to pay off a debt, or medical bills. Sometimes, the rising cost of property taxes no longer makes it worthwhile to hold onto the property.
But whatever the reason, it can be hard to know if it is the right time to sell a rental property, so we put together a guide for you.
We'll walk you through the entire process of selling rental property while avoiding as much tax hit as possible so you walk away with more cash from the sale.
Signs It's Time to Sell a Rental Property
Soaring Home Sales Prices
According to the National Association of Realtors, the median price of property sold in 2012 was just $154,700. Now as of June 2022, according to the United States Department of Commerce, median home sales price are at $402,400! 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 a hot seller's market, it only takes around 25 days for a home to sit on the market before being sold. You can take advantage of this momentum in real estate, because who knows how long it will last?
Changing Local Market Conditions
Perhaps job and growth opportunities in the town your rental property is located in is slowing down. Thus, tenants are harder to come by, and your investment property is idling away unoccupied. It may be time to cash out and invest elsewhere.
You can talk to a real estate agent in your neighborhood if you'd like more information on market conditions.
Rental Property Needs Repairs
If your rental property has major issues needing costly repairs such as foundation problems and septic system failure, it may be more sensible to sell it rather than put more money to keep it.
Most real estate investors are looking for these so-called distressed properties, so you'd have no problem offloading a problem property.
Rental Property is Inherited Property
You may have inherited a rental property but you live out of state, or you think you're not cut out to be a landlord. If this resonates, you can opt to sell the rental property and cash out, allowing you to realize the gains.
You Want to Retire from Being a Landlord
Property management is not for everyone. You may be tired of collecting rent, finding and talking with tenants, and dealing with property upkeep... These are signs that it's probably time to cash out for other opportunities.
How to Have a Smooth Rental Property Sale
Selling a rental property can be tough and challenging in any market condition, but here are some steps you could take in order to sell your rental property as painless and hassle-free as possible.
Know the Type of Buyer You Want
Before anything else, you have to find out the type of buyer that you want. This will help determine what marketing strategy to employ, how to price the rental home appropriately, and what to do with your existing tenant.
Do you want to sell to a real estate investor, a first-time homebuyer, or your existing tenant? These potential buyers all have different expectations in the property they are purchasing. So, in order to attract any of them, you have to align with them.
Arrange a Pre-listing Home Inspection
One of the best ways to get the best price for the rental property that you're selling is to have a clean bill of health from a professional home inspector.
An inspector would take a look at every nook and cranny of your property and recommend the necessary repairs to bring it up to standard.
Decide If It Is Worthwhile To Do Repairs or Sell As-Is
A clean, updated, and fresh-looking property listed on the real estate market usually fetches a better asking price than a rundown one. Some first-time real estate investors are looking for a property they could rent out immediately to tenants.
This decision ultimately boils down to whether you have the time, energy, or money to invest upfront in repairs and rehabilitation with no guarantee that you'll be able to recoup it after the sale.
If your rental has suffered a lot of issues from horrible neglect, possibly due to careless tenants, it might make more financial sense for you to sell it as-is to a real estate investor to let them deal with the problem.
Real estate investors are usually cash buyers. They can close on a sale quickly since they are not waiting around for their mortgage to be approved, unlike a traditional buyer.
Do a Lien Search
An escrow officer can help you with a title search to find out if your rental property has any other encumbrances you may not know about so you can take care of it ahead of time, ensuring the real estate transaction goes as smoothly as possible.
Inform Your Tenant about Your Intention of Selling the Property
Your tenants must be informed of your desire to sell the property to give them ample time to relocate.
You can also give them an incentive to encourage the move. However, you must be mindful of the rules in your state, especially now that the COVID-19 pandemic has brought about rules regarding giving tenants their notice to vacate.
Study the Tax Implications of Selling a Rental Property
When you sell a rental property or any other real estate assets, tax payments should be made such as depreciation recapture tax, or any remaining capital gains tax.
Depreciation Recapture Tax
Depreciation expense is used by property investors to reduce their taxable net income during the years that they own their real estate investments.
However, once the rental properties are sold, this depreciation must be recaptured and taxed according to the tax bracket where the property owner belongs (up to 25%).
Capital Gains Taxes
If you owned the rental property for a year or less, the profits you make in the sale will be short-term capital gains, and it will be taxed at the same rate depending on your tax bracket. This means you will be required to pay tax anywhere between 10% to 37%.
On the other hand, if you owned the property for more than a year, the profits will then be considered long-term capital gains. You will still owe capital gains tax, but it is a much lower rate: 15% for joint filers with taxable income ranging from $80,800 and $501,600; and 20% for joint filers with income above $501,600.
If your taxable income is below $80,800 annually, then you wouldn't need to pay capital gains tax.
Even if you do not fit the above criteria, there are still workarounds in avoiding hefty capital gains taxes, which we will discuss below.
Illustrative Example of Tax Consequences when Selling a Rental Property
Let's say you acquired a rental for a purchase price of $80,000 and today it sold for $120,000. Over a five-year holding period, you have claimed a $10,000 depreciation expense.
Let's assume you belong in the top tax bracket, therefore a 25% depreciation recapture tax rate and a 20% capital gains tax rate applies:
$10,000 x 25% depreciation recapture tax rate = $2,500
($120,000 - $80,000) x 20% capital gains tax rate = $8,000
In this example, the tax bill is $10,500.
Take note though, tax rules may vary depending on your personal situation, so after reading this guide, it would still be better to consult a tax professional or a real estate attorney.
Considerations when Selling a Rental Property to Avoid a Tax Hit
Take Advantage of the 1031 Tax Deferred Exchange on an Investment Property
A 1031 exchange takes its name from Section 1031 of the Internal Revenue Code, and is basically a tax break. You are able to defer capital gains taxes when you sell rental property, but it is subject to the following rules:
- The real estate to be acquired must be for business or investment
- You must use the proceeds to purchase a replacement property of equivalent or higher value
- After closing on the sale of the previous property, you have up to 45 days to identify a replacement property
- After closing on the sale of the previous property, you have up to 180 days to close the deal on the replacement property
There are lots of benefits of a 1031 exchange, foremost among them is an opportunity to invest in a real estate portfolio elsewhere.
For example, if you have a single-family rental property in an expensive housing market such as California (median home price = $505,000), you can proceed to sell it and use the funds to purchase multiple investment properties in another state, say, Utah (median home price = $279,100).
Consider Living in Your Rental Property Prior to Selling to Avoid Capital Gains Tax
When selling your primary residence, you wouldn't need to pay capital gains tax on a profit of up to $500,000 when filing with your spouse; or, if filing singly, you can have a tax shield of up to $250,000.
However, in order for this benefit to be available to you, you must pass the Internal Revenue Service (IRS) ownership test per the Taxpayer's Relief Act of 1997:
- You must own the rental home for at least two years
- The 2-in-5 year rule: meaning you must live in the property for two years or more in the five years you have owned it prior to selling the property
From a tax savings perspective, it is more beneficial to sell it as a personal residence than just unloading it as a rental property.
A little reminder though, selling your personal residence does not qualify you for a 1031 deferred exchange.
Evaluate the Property for Possible Tax-Deductible Repairs
Undertaking repairs on your property not only makes it more attractive for potential buyers, it is possible to claim tax deductions on it as well. A caveat though, these repairs are only tax-deductible if they are done to keep the property in good working condition, and not to add value.
Consult a tax professional to know more about tax-deductible repairs.
Use Tax Harvesting to Offset the Capital Gains
Not all properties in an investor's portfolio are winners. Sometimes, you may be forced to realize the loss if the investment property is not performing as well as expected.
Well, you can use this realized loss to offset the capital gains from another property that you are also selling in the same tax year. This is called tax harvesting.
For example, you have a rental property with a negative equity of $35,000, and another property with a $60,000 capital gain. The loss will be subtracted from the gain resulting in only $25,000 taxable capital gain.
Selling Rental Property with a Tenant
Selling a tenant occupied property is much easier if you have an early termination clause in the lease agreement, you would just follow the procedure outlined in the next section.
The current lease can be terminated on the following grounds:
- Terms of the lease were not honored by the tenant
- Property is grossly neglected by the tenant
- Landlord has been repeatedly unable to collect rent
- Landlord wants to sell the property
However, even if you don't have an early termination clause in your contract, you will still be able to sell your tenant occupied property, you just have to do any of the following:
Wait for Your Tenant's Lease Expiration
If your tenant is following the rules and paying rent on time, they have every right to stay in the property during the entirety of their lease period.
In this case, you have to honor your contract and wait for the lease to expire before offloading the property. At least you're getting rental income as you wait.
Sell Property to Your Existing Tenant
Before putting your rental property up on the market, why not consider offering it to your tenant first?
Here is someone who already likes your property (obviously!), so they can stay and skip the hassle of moving while you cash out of your investment property. You won't even have to deal with real estate agents and their commissions since you would be selling directly.
If they are unable to get traditional financing, you can offer them seller financing until they can secure a mortgage. It is advantageous to you too, as the seller, since even in a buyer's market, you will be able to get your asking price.
Sell Your Rental Property with an Active Lease
Most rental property owners find rental properties with an active cash flow attractive. If you'd like to cash in your gains and hand over the reins to a new landlord, then you can opt for this. The buyer can then let the lease expire or renew it.
Offer your Tenant to Vacate
You can also incentivize your tenant to vacate the premises when you are ready to sell so it will be a win for everyone. You can compute the incentive based on the following:
- Moving cost
- Rent differential - For example, there is a nearby property your tenant could move into, but the rent is higher. You could offer to pay for the difference for the remainder of their current lease
- Security deposit - Moving to a new property would mean putting up a security deposit equivalent to a month's rent. You could help out your tenant by offering to pay this for them
- Lump sum - If a decent profit from selling your rental is on the horizon, you can offer your tenants a larger sum to encourage them to move
Steps in Selling a Rental Property
Once all tax-related concerns are out of the way and your rental property has been vacated, or you have come to a cheerful conclusion in negotiations with your tenant, selling a rental property is just like selling a house.
Depending on the property's condition, you have 3 main options for how to sell rental property.
1. Real Estate Agents
If the rental property is in good condition, work with real estate agents who will be in charge of the staging, showing, negotiating, and closing on the potential buyer. They will provide you with real estate advice on how to make your property more attractive.
This convenience comes at a price in terms of paying commission to your real estate agent, repair and renovation costs per their recommendation, and all the associated costs in a home sale.
2. For Sale By Owner
Sell your rental property yourself (For Sale by Owner) if you have sufficient time and energy to invest in marketing your property.
You will be responsible for the staging, showing, negotiating, and closing. Lack the experience needed to garner a worthwhile price?...
3. Real Estate Investors
Sell to a real estate investor to save time and skip the hassles. A huge advantage in selling to an investor is you get to cash in your investment property while doing very little.
They typically look for sellers of as-is properties, so you wouldn't have to worry about fixing up the property or making it look nice. You don't even have to arrange a professional home inspection!
The only thing you have to be prepared about is to sell at a discount since property investors factor in all the possible repair and rehabilitation costs in their offer. You must expect to sell the property for below market value.
But then again, you benefit from a quick sale and at the same time, you walk away from a problem property with money in your pocket, so it depends on what you value in your home sale.
Closing Thoughts: How to Sell Rental Property Without Paying Taxes
There are several ways that you could cash in your investment while avoiding a hefty capital gains tax bill 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 Sell My House Fast, we strive 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 quickly as 7 days, and we even cover all closing costs for you!
If you'd like to talk, call us at (844) 207-0788 and we look forward to hearing from you!