Selling an investment property before classic “retirement” is extremely far off for us at 40PlusFinance.com. Our core strategy is to buy and hold real estate for 30+ years all building up cashflow until we become financially free.
Honestly, we haven’t fully decided on what we will do once we “retire”, but don’t envision ourselves ever completely stopping work.
However, with that said, there are a lot of people who fall into the “tired landlord” category who will eventually want to sell their investment property before retirement. Fair enough.
What this means is that you will give up the rental income and cashflow that the home has been growing over the years. This also means that you will have to pay a significant amount of capital gains tax at the end of the year. Even though there may be some negative consequences, some investors may still decide to sell.
This article will talk about some of the advantages and disadvantages of selling an investment property before retirement, and look at some ways to keep a rental property while reducing taxes when the investment home is sold.
- 1 Should I Sell or Keep My Investment Property
- 2 Things to Consider When Selling Investment Property Before Retirement
- 3 When to Sell Investment Property
- 4 Options for Minimizing Tax Liability
Should I Sell or Keep My Investment Property
There are a ton of different things you need to consider before making this decision, including diversification of your real estate portfolio and most importantly, tax consequences. Here are a few things to keep in mind.
Things to Consider When Selling Investment Property Before Retirement
The timing of when to sell an investment property is a personal decision that is based on an investor’s individual financial situation.
Some experts warn that if you wait too long to sell your rental property, you could end up owing a lot in capital gains taxes, especially if property prices keep going up.
An investor could make a profit from selling their property if they assume that home prices will continue to go up. The longer the property is held, the greater the potential profit could be. This means that while you may have to pay more taxes, you could also receive more money in return.
On the other hand, some investors may choose to sell while home prices are high, in case the real estate market enters a typical downward cycle. If you have a lot of equity in your rental property, you may start thinking about selling it and using the money for other things.
Here are some of the possible pros and cons to consider to help decide if selling before retirement is a good or bad move:
- Free-up accrued equity by selling, then use the cash for other uses, such as buying a vacation home or adding to a retirement fund.
- Eliminate ownership responsibilities such as reviewing financial reports from the property management company, worrying about potential negative cash flow, or ensuring that tax filings to the IRS are true and correct.
- Have extra time to do more enjoyable things, such as traveling, beginning a hobby, or spending more time with family.
- Loss of the rental income that could be used to supplement other retirement income.
- FOMO – or fear of missing out – which is the anxiety that comes with selling too soon and missing out on potentially bigger profits.
- Capital gains taxes and depreciation recapture tax will have to be paid when an investment property is sold.
When to Sell Investment Property
If you’re thinking about selling an investment property, it’s worth considering whether the profit you make from the sale will be greater than the future value growth of the property and the passive rental income you could earn from keeping it. If you cannot sell in a sellers market, you should use the profits to invest in another opportunity or to diversify your portfolio.
1. Being a Landlord Is More Difficult Than You Had Imagined.
You probably know the ins and outs of being a landlord.
Since emergency maintenance calls come at all hours, you need to be available to answer your phone, which can be draining.
A landlord, a tenant involved in hard-core drugs, and the FBI were all involved in a raid. The woman who moved out without notice left her cats behind and unattended for three weeks.
The horror stories go on. If you have been a landlord for a long time, you might have your own stories.
Many businesses start out with high hopes and the aspiration to do better than similar businesses.
Unfortunately, things can turn out significantly different than expected. It may be time to sell the rental property if:
- Being a landlord has become too much work and you’re overextended.
- Your tenants are consistently a problem.
- Your plan for being a part-time landlord has shifted into full-time work.
Landlord aggravations aren’t limited to tenants, of course. There are things to worry about like maintenance, changing values, and even disasters like earthquakes and floods.
If the stress of the job is not equal to the amount of money you are making, it might be time to quit.
If the stress of maintaining a proper living space for your tenants or dealing with difficult renters is too much for you, you may have reached your limit.
Landlords of rental properties have a lot of responsibility. Selling your property is likely to make you feel better if you are no longer enthusiastic about your landlord responsibilities.
2. Your Property Is Now Worth More Than When You Bought It
In order to make money through investing in real estate, it is important to make sure that the value of the property you are investing in goes up over time. If your flipped property is now worth more than the original purchase price, you could make more money by selling it than by renting it out.
You may have purchased a piece of property in an area that has experienced growth and is now doing well. That’s great!
It also (likely) means your property value has increased. If you want to make money, this may be the sign you are looking for.
3. You No Longer See a Positive Cash Flow
If you are in the red each month, it might be time to take a look at your budget. There are many reasons your cash flow might be decreasing, and it’s not always anyone’s fault.
Either the cost of taxes, utilities, and insurance has gone up or market rents have decreased, or both have happened.
You didn’t choose to be a landlord in order to have a glamorous and exciting life. The main reason you became a landlord is probably to make money.
It’s a numbers game. Earn more than you spend and you’re winning. Spend more than you earn and you’re losing.
Recognizing that it’s time to quickly sell your investment property can be tough. Accumulating debt can feel like a greater defeat than being in the red each month.
If you want to remove emotion from the equation, ask yourself a simple question. As The Washington Post puts it:
Would you buy the investment now if you were thinking about it? Investors have a tendency to hold on to bad assets for too long in the hopes that they will improve. If you’re not interested in buying this investment, you should get rid of it.
In addition to the capital gain taxes (which could be up to 22% of the selling price), you would also have to pay for any repairs that need to be made and you would continue to have negative cash flow.
Try as you may, you may find that your balance sheet has determined your course for you.
4. You Have Better Ways to Generate Passive Income
Real estate investing can be a great way to make money without having to work for it. There are other companies like REI and it is important to invest in different types of companies to get the best return on investment.
There are many ways to create a passive income stream, such as from dividends, bonds, CDs, and REITs. Out of these investment options, real estate investing is not the simplest, as anyone who has been a landlord or owned rental properties can attest.
There are definitely a good variety of ways to generate passive income, but still stay involved in real estate. The first that comes to mind is through syndications, especially if you are an accredited investor.
Our own personal perspective is that we will, at a minimum keep enough turnkey rental properties to generate cashflow to exceed our expenses. Once we reach that point we will re-evaluate things and all options are fair game.
Options for Minimizing Tax Liability
The example above is just for one property. The amount of taxes you would have to pay if you sold an investment property before retirement could go up based on how many rental homes you have in your portfolio, if every investment has increased in value over the time you’ve held it.
An investor has a few options to help reduce the amount of taxes owed if a property is sold.
Wait Until Retirement
Once someone retires, they often find themselves in a lower tax bracket than when they were working. If you wait to sell your investment property until after you retire, you may be able to pay less in taxes on capital gains and depreciation recapture, depending on how much income you have that is taxable by the federal government. An investor could collect additional income by waiting to sell until retirement.
Offset Capital Gains with Losses
An investor can reduce the taxes they owe on profits from the sale of an asset by offsetting those gains with losses from the sale of another asset. An example of this would be if an investor had stocks that were sold at a loss, the amount of the loss could be used to lower or get rid of the taxable gain from the sale of an investment property. If an investor has more losses than gains in a given year, they may be able to carry the loss forward to later years.
Move into Rental Property
If you want to minimize the amount of taxes you have to pay when selling an investment property, you could move into the rental and use it as your primary residence. However, this option can be a bit tricky. The amount of money you are able to make from selling your home without having to pay capital gains taxes will depend on how long you have lived in the house and whether or not you used it as an investment property. The depreciation expense you claimed when the home was an investment property will be taxed as income when you sell the home.
Conduct a 1031 Exchange
An option to consider for investors who aren’t ready to retire their investments is a 1031 tax deferred exchange. If investors sell one investment property and replace it with another, they can defer the payment of capital gains tax and depreciation recapture tax. There are strict requirements for IRS 1031 exchanges, including that a replacement property must be identified within 45 days of the sale of the relinquished property, that the sale of the replacement property must close within 180 days, and that the funds must be paid through a qualified intermediary.
There are two other strategies investors use to reduce potential tax liability over the long term without actually selling the investment:
Form an LLC
The ownership of an investment property can be transferred into an LLC, with the investor, family members, or other individuals owning shares of the LLC. The LLC is owned by each member, and the rental property is owned by the LLC. Transferring shares among family members is still possible, even after the investor has died. Some investors who own multiple rental properties choose to form an LLC for each individual home. Others prefer to place all of their rental properties under a master LLC or a real estate trust.
Transfer Property to a Trust
An investment in a real estate trust for rental property may have several benefits, such as avoiding taxes on capital gains and depreciation recapture, as well as avoiding the probate process, which can be costly and time-consuming.
After forming a living revocable trust, the real estate investments should be transferred to and retitled in the name of the trust. The investor retains control of the property when alive. Upon the death of the investor, the trust may become irrevocable, meaning a trustee is appointed to manage the assets within the trust for the benefit of the trust’s beneficiaries.
The “step-up basis” is the value of a property for tax purposes when it is inherited. If the investor’s heirs sell the inherited rental property soon after the investor’s death, they may have to pay only a small amount in taxes on their profit.
With all of that said, if you are still interested in keeping your investment property utilizing a buy and hold strategy, make sure to check out our post on the Wealth Snowball Financial Freedom Plan and it’s free calculator.