Making the Decision to Sell
The reasons why a property owner may decide to sell a rental property include:
- wanting to buy a different investment,
- cashing in on the appreciation of a rental property rather than accumulating money through rent,
- minimizing the cost of a property that is losing money, or
- feeling fed up with property management.
Regardless of the reason, real estate investors looking to sell will have to deal with taxes. However, if you don’t have to sell, consider the following before doing so:
- What is the current housing market where your investment property is located? Is it a buyer’s or a seller’s market? If you don’t have to sell in a buyer’s market, don’t. Wait until there are fewer sellers or more buyers.
- Can you use the sale profit to make a better investment? A 1031 exchange (aka Starker’s Trust) can be used to protect your gain going forward, although requirements are somewhat restrictive (see below) and timing is essential.
- Why should I wait? Lack of pressure to sell provides you with the ability to wait for multiple options and the best deal.
If you are selling because you need the capital, you will have to pay some taxes. Discuss your situation with a tax advisor before putting your property on the market to make sure you are making the best decision possible.
Financial Implication of Investment Property Sales:
When you sell your out-of-state property, it can cost you in a number of ways, such as:
- capital gains tax,
- real estate agent commission fees,
- Medicare surtax.
There are strategies for deferring or reducing the gain from the sale of real properties:
- If you intend to reinvest your sale assets into another investment property equal or greater value, you may be able to file a 1031 tax free exchange, also known as a Starker Trust, which allows you to defer all capital gains tax owed until the sale of the newly-purchased property. However, there are a number of restrictions to qualify for this exchange. For example, you have to identify the property(ies) you want to acquire within 45 days after you close on your sale property, and you must close on the new property(ies) within 180 days of the initial sale.
- If your rental property qualifies for a Maximum Exclusion Allowance (MEA), there is a $250,000 exclusion ($500,000 if married, filing jointly) for the gain from the sale of a person’s principal residence. This may not be applied unless you, the owner, have lived in the residence for at least 2 of the last 5 years prior to the date of sale. In addition, you cannot have acquired the residence through a 1031 exchange within the last 5 years. However, if you meet all requirements noted in IRS publication 523, your sale will qualify for an exclusion of $250,000 gain ($500,000 if married filing jointly). For more information, see http://www.irs.gov/publications/p523/ar02.html.