by Mindy Jensen
In this red-hot market most of America is currently experiencing, it can be tempting to cash out your investments, take that (in some cases) extreme appreciation, and move it to another investment. Perhaps you’re tired of tenants and toilets and would like to investigate notes instead. Maybe you’d like to explore larger properties or even participate in syndication deals.
Selling Rental Properties
As market conditions have become more favorable, it’s time to evaluate your portfolio and sell off some of those dogs. The properties that do not perform as you thought they would, the ones that are difficult to rent for whatever reason, or those just plain weird ones. Sometimes, a property just doesn’t work out, no matter how good those numbers looked when you analyzed it.
If your market has taken a turn for the better, now is an awesome time to sell. But do you sell with the tenant in place or do you wait until it’s empty?
Occupied vs. Vacant
Both ways have pros and cons. Selling an occupied property means someone is there to foot the bills while you list, go under contract, and close on the property—far less cash out of your pocket. If you’re selling to another landlord, they have one less thing to do after closing. A great tenant—complete with on-time rent payment records—can go a long way to getting a sale.
However, when someone is looking for a home for themselves to live in, an occupied property is not ideal. A property with a lease that ends in the next month can still be put on the market with the hopes of attracting an owner-occupant buyer, but generally, you will be marketing to the investor crowd when trying to sell an occupied property. This isn’t all bad. Investors understand tenants. But investors also want a deal.
Consider these things when selling an occupied rental.
- You can’t kick out your tenants before their lease is up. The lease runs with the property, not the owner. You can’t deliver the property vacant at closing if there’s still six months left on the lease and the tenants want to stay. You can offer to buy out the tenant – but if they say no, you’re out of luck.
- Work with your tenants. Trying to sell a property with tenants in place means your tenants, not you, are the ones who are inconvenienced. They are also the ones in the driver’s seat. If they don’t clean their unit before a showing, you’re going to be getting much lower offers. If they make it difficult to show the property, you may not get any offers. Consider offering rent discounts for showings or coordinating a weekend showing to minimize their inconvenience. Ask what times they’d prefer to have people view the property, and only accept showings during these times.
- Sweeten the deal with great records. Landlords care about the bottom line. Telling someone that rent is $1,000 a month is great, but being able to back up that statement with written proof is even better. Have your tenants fill out an estoppel statement, which shows how much the tenant is paying in rent and the amount of their security deposit. You should be keeping good records as a landlord anyway, so show potential buyers the payment history of the tenants, along with any expense and repair records.
A vacant property is a lot easier to sell, but you pay for everything until you close. All utilities and any exterior maintenance that may have been paid by tenants now rest on your wallet. You also have to secure the property—with no one living there it can be an easy target for copper thieves and squatters.
However, when it’s vacant, you can accept showings at any time of day or night and you know it’s clean because there’s no one and nothing there to make it dirty.
Decide what works best for your selling time frame.
Legally Avoiding Taxes
At the time this is written (late 2017), you have two ways you can legally avoid paying taxes when you sell your property. Both look to be headed for alterations in the new tax bill, but have not yet been changed. Definitely check with your CPA for up-to-date tax information; there is no set time for this to change.
Section 121 Exclusion
The Section 121 Exclusion, more commonly called the “two out of five rule,” comes from the 1997 Taxpayer Relief Act. Prior to the Act, you had to buy a more expensive home in order to defer capital gains taxes. But Section 121 now eliminates capital gains taxes up to $250,000 for single homeowners and up to $500,000 for married homeowners.
But, there’s a catch. (It’s a government program—OF COURSE there’s a catch!)
- This is ONLY available for your primary residence. You MUST have lived in and owned the property for two of the last five years. You can still use this to sell a rental property, but only if you meet the two out of five years’ residency requirement.
- You can only do this once every two years. Those two years do not have to be consecutive. You can break them up; the time lived in the property just has to be equal to two years.
If you meet these requirements, you can save yourself a ton of money. If you are just shy of the requirements, it can be well worth it to move back into the property to make sure you hit them all.
You should absolutely consult with your CPA before trying to claim this exemption, especially if there is any question if you meet the requirements.
What you are far more likely to qualify for when selling your investment property is a 1031 exchange. While this does not exempt you from capital gains taxes like the Section 121 Exclusion, it defers them, essentially kicking the tax-can down the road.
Again, since it’s a government program, there are rules. A LOT of rules. Forget to dot just one “i” or cross just one “t,” and you can blow the entire thing out of the water, owing capital gains taxes you could have avoided. And the rules aren’t “common sense” rules, either. Nope, it’s a government program, complete with government red tape, seemingly pulled out of thin air for no logical reason whatsoever.
First off, you need a qualified intermediary to facilitate the transaction. If you’re planning on doing a 1031 exchange, start looking for a QI right now. Ask for recommendations in the BiggerPockets forums for a reputable QI. Once you’ve decided on the QI, follow their every direction—and ask as many questions as you need to understand the process.
There are hard and fast dates you must follow, forms to fill out, and documents to file. Your QI must be included in the sale transaction BEFORE it closes and must also be included in the purchase.
The requirements get really complicated, so do NOT take this overview as gospel. You need a QI involved in the sale and subsequent purchase anyway. Make sure to follow their instructions. However, here is a brief overview:
- You have to buy an equal or more expensive property.
- You must use all of your net proceeds from the sale for the new purchase.
- You must identify your new property within 45 calendar days of the close of the current property.
- You must close on the new property within 180 calendar days of the close of the previous property.
- You must have owned the previous property as an investment property.
- You must purchase the new property as an investment property.
There are many more rules to follow, and your QI will be able to guide you through the process. But you MUST get your QI involved in the sale of the current property in order to take advantage of any of the 1031 exchange benefits. Don’t sell an investment property without consulting a CPA and a qualified intermediary.
Selling a Fix and Flip
There is such a sense of satisfaction in taking an ugly house and turning it into a beautiful, modern dwelling. There is also a nice, fat paycheck at the end if you do it right. This is my preferred method of investing, and I combine it with the Section 121 Exclusion to eliminate capital gains taxes. But this is a plan that I implement from the time I purchase the property. If you have not lived in the home for two years, you cannot eliminate capital gains taxes.
You can still move into it, live there for two years, and then sell. The clock starts ticking when you actually move in, not when you bought the home, so you’ll be adding two years to your selling timeline. Not everyone’s timeline will have two years in it.
I think it goes without saying that you should not cut corners or do shoddy work. Of course, every time I say, “It goes without saying,” I find an instance where it needs to be said. Don’t do bad work, and don’t let your contractors get away with sloppy work, either.
There’s a debate whether you should start marketing the property before you’ve completed the remodel. While there is only a minimal cost to planting a sign in the front yard that says “coming soon,” buyers have zero imagination, and seeing what a home looks like mid-rehab can be too much for some people.
I don’t advertise my flips until I’m finished. I’ve had too many bad responses from potential buyers who didn’t understand the process.
Here are tips for selling a flipped home after the rehab is complete:
- Stage the property. Most people can figure out what to do with a master bedroom or living room, but those weird spaces or odd nooks can be confusing. Buyers have absolutely no imagination, and anything you can do to help them visualize these spots that aren’t obvious can help get your home sold faster.
- Make a binder about the home. In this binder, put every appliance manual (with a notation when it was installed if available), all warranty information, the name of any contractors you used, and any other pertinent information about the property.
- List (almost) everything you’ve done. Not all improvements are obvious, but that doesn’t mean they’re not important. New doorknobs and light switch covers aren’t something anyone is going to care about or notice. On the other hand, new electric service or plumbing work isn’t visible, but super important to note. Go through the home, room by room, and note everything you’ve done, especially those repairs that aren’t apparent. When you’ve recently purchased the home and are asking a significantly higher amount than you paid for it, you want to make it abundantly clear why you’re asking so much more for the house. Put a copy in the binder and print one out, frame it, and leave it in a very obvious place in the home during showings.
Timing the Market
For every investor who sells right at the very peak of the market, there are 12 billion who miss that peak on either side. OK, that’s a made-up statistic, but I’m trying to prove a point. You cannot time the market. Trying to do so is an exercise in futility.
Someone is always going to sell a house for a higher price than you, just a short time after yours closes.
Someone will always sell a property right before you do, for more money than you are able to get.
Sell because you are happy with your returns. Sell because you want to own something different. Sell because you need to cash out, but sell because it is time to sell, not because you’re trying to time the market.
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