Selling Investment Property How to Sell Your First Rental Property by Ben Mizes April 15, 2020April 23, 2020 by Ben Mizes April 15, 2020April 23, 2020 Maybe you’re tired of being a landlord, or maybe you’ve just decided that you prefer a lump sum of cash instead of a trickle of rent. Whatever your reason, you’ve decided to sell your first rental property. Good! The whole reason you invested in this property was to make a profit, and selling is a great way to do that. However, selling a rental investment property is a lot more complicated than selling your home. You can’t just find a local agent, have a couple of open houses and cross your fingers. The tax implications of selling an investment property, especially, can be brutal. Luckily, there are ways to soften that blow, and maybe even upgrade your portfolio in the process. Let’s take a look at each step of the rental sale process, and discuss ways to optimize your outcome. Why Are You Selling? It’s important to examine your motives for selling. Are you tired of being a landlord? That’s understandable— there are few jobs more stressful than attending to the needs of multiple tenants, 24/7— but before you sell, consider using a professional property management service. It’ll typically cost you a percentage of rents collected, but it can be worth it, especially if you end up retaining a property that dramatically appreciates down the line. On the other hand, maybe your rental is losing money. If you don’t want to make improvements that would allow you to raise the rent, or if the market’s simply reached its ceiling, selling makes financial sense. How to Sell As we mentioned before, selling an investment rental isn’t like selling your home. It’s a different market, with different buyers. And those buyers won’t be looking at the property like a conventional buyer would; they don’t care about curb appeal and bathroom finishes as much as they’ll want to know about current lease agreements and cash flow history. One newer selling option that’s becoming more popular is selling online. Sites like Roofstock or Rentecdirect let you list your rental property on the website, upload the pertinent information, manage bids and offers, and even close the sale, all through the website. These are centralized, convenient ways to reach your target buyers, and they’re a lot more effective than open houses. Related: 4 Best Ways to Sell Your Home Online Also, don’t ignore the traditional channels regular homeowners use like MLS listing services, a sign in your yard, professional photos, social media, and print advertising. All of these smaller advertising activities can help you sell: Just remember your audience. The Tax Issue If you decide to go forward with the sale, you should make sure you understand all the tax implications first. Selling an investment property means you’ll owe a significant amount of capital gains taxes on the profits. And if you claimed yearly depreciation against the rental property, you’ll have to pay capital gains taxes on that, too, along with the profits. Let’s look at an example: let’s say you bought a rental property for $200,000, and you’re now selling it for $250,000. You’ll owe capital gains taxes on that $50,000 profit. If you also claimed depreciation of, say, $40,000 over the time you owned the property, that’s subtracted from the original purchase price when it comes time to assess capital gains. So instead of owing on a straightforward profit of $50,000, you now owe capital gains on the difference between $160,000 (the original price, minus $40,000 depreciation), and the sale price of $250,000. Factoring in depreciation, you owe capital gains on $90,000, instead of $50,000. If you find that figure alarming, there’s a way to defer that tax liability— potentially indefinitely. Deferring Taxes with the 1031 Exchange What if you could essentially trade your rental property for a better, more valuable property, while also avoiding capital gains taxes? That’s exactly what the 1031 exchange can do for you, and why it’s one of the most powerful tools for real estate investors. The 1031 exchange is a tax provision that allows investors to take the proceeds from the sale of a property, and immediately flip those profits into the purchase of a new property while deferring capital gains. There are certain restrictions; the initial property and the replacement property must be “like-kind,” which means they must be similar in type. You can’t use a 1031 exchange to trade a single family home for an office building, but you can use it to upgrade from a multi-family complex to a larger, more expensive multi-family complex. There are time limits, too; you must identify replacement properties within 45 days of the initial sale, and close on the replacement property within 180 days. That’s a tight time window, so if you do opt for the 1031, make sure you start surveying potential replacement properties before you put your initial property on the market. Search for My Investment Property One of the remarkable provisions of the 1031 exchange is that you can use them repeatedly. That is, after trading up once, and deferring those capital gains taxes, you can use another 1031 exchange to trade up to a third property, once again rolling over and deferring your tax liability. In this way, investors can literally defer their capital gains taxes forever, or until their death. Closing On a Rental Property When you sell a rental property, most of your closing costs are tax-deductible— but in different ways. The only closing costs that are immediately, directly deductible are mortgage interest, certain mortgage points, and qualifying real estate taxes. You can deduct those on your annual tax return like regular expenses. The rest of your closing costs can be indirectly deducted by including them in the basis of your property, which is a measure of the total cost of the property. Since your annual depreciation is going to be based on the basis (hence the term), including your closing costs in the basis means you get to incrementally deduct them as the years pass. The Question of Incorporation Incorporation can be a great way to protect yourself and your assets; if, for example, a tenant sues you, your home and personal finances can’t be seized in any legal proceedings if you’re incorporated. Corporations also benefit from different tax rules than individuals, especially when it comes to capital gains taxes. Incorporating does have its downsides, though. Your income will become much less readily accessible, as it must now be accessed through the structure of the corporation. The same goes for your properties; once they’re owned by the corporation you’ve created, they can’t easily be sold or transferred back to you. Doing so without selling the corporation itself could trigger a tax evasion or tax fraud investigation by the IRS. The bottom line is, incorporation probably only makes sense for large-scale investors with multiple employees and incomes that significantly exceed their expenses. For smaller investors, there are better and easier ways to reduce their tax liability. This article has been contributed by Ben Mizes. Start Your Investment Property Search! START FREE TRIAL Guest BlogsMarketingTax Benefits 0 FacebookTwitterGoogle +PinterestLinkedin Ben Mizes Ben Mizes is Co-Founder and CEO of Clever Real Estate, a service that connects top-rated, full-service agents with home buyers and sellers at a discount rate. Luke is also an active real estate investor with 22 units in St. Louis and a licensed Real Estate Agent in the State of Missouri. Previous Post Spring Real Estate Market 2020: 4 Tips for Buyers Next Post How to Find REO Homes for Sale in 2020 Related Posts Are There Disadvantages of Seller Paying Closing Costs on Behalf of the Buyer? Should You Ever Accept a Lowball Offer on Your House? How Do You Know You Have a Rental Property for Sale? What Are the Best Property Investment Strategies for Part-time Real Estate Investors? What types of property make for the best real estate investments? 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