Selling a Rental Property? 4 Crucial Points to Consider | realtor.com®

Selling a Rental Property? 4 Crucial Points to Consider | realtor.com®

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Street Smart REI  

We've discussed the process of selling a house[1] you live in, but selling a rental property is an entirely different bird. For tax purposes, a rental house or condo is considered an investment property, which makes the sale a bit more complicated. When you sell a rental it can be subject to different taxes and rules than a standard residential sale. Read on for the essential facts.

1. Your tenant may have first right of refusal

One of the first things to understand is how local real estate laws will affect your sale. Real estate expert and author Michele Lerner says, for example, in Washington, DC, tenants have a “first right of refusal[2],” which means that landlords need to notify the tenant when they are putting the property on the market and must provide the tenant with a complete disclosure of the sales price and other information about the property.

The tenant has a specific time period during which he can respond to the landlord and either make an offer on the property or decline to buy it. After that, if the owner receives an acceptable offer from someone other than the tenant, the tenant will have another chance to match the offer or decline to buy it.

“None of this may apply in your area, but it’s important to be aware of local legislation when you sell property,” Lerner says.

2. Don't rule out a rent-to-own arrangement

Pricing is often the most difficult negotiation you'll have if your tenant wants to buy the property because he may feel that he deserves a break on the price, says Kathryn Bishop, a Realtor® in Studio City, CA.

"The tenant may want their past rent applied to the purchase price," she says. "They may also have a list of things that are ‘wrong’ with the property and want financial discounts bigger than another buyer might ask for.”

If your tenant is having trouble coming up with a sizable down payment to get a mortgage on your property, you can arrange a rent-to-own[3] arrangement with your tenant—but make sure you have an attorney write up the agreement so your interests are protected. Typically, you'd charge a bit over-market rent that you credit to the tenant toward his down payment. And the tenant could work to increase his income, reduce his debt, or save for a bigger down payment during the rent-to-own period.

3. You have to pay capital gains taxes on a rental property

When it comes to paying capital gains[4] taxes, there are major differences between selling a rental property and selling your primary residence, says Sean T. O’Hare, a CPA with O’Hare Associates in New England.

"Since a rental property is considered an investment property, when you sell the rental property you must pay capital gains on the income," O'Hare says. "A taxpayer does not receive an exemption for the sale of an investment property."

If the property was used only as rental property, then the capital gains would be calculated on the selling price less the adjusted basis of the property. The adjusted basis is the original cost less the depreciation. A residential rental property is depreciated over a period of 27.5 years on a straight line basis; basically, take the original cost divided by 27.5, and that is the annual depreciation amount.

"I usually tell my clients that they should plan on about a 22% tax to the IRS on the sale of rental property," says O'Hare.

If a taxpayer selling a rental property wants to minimize the amount of capital gains or potentially avoid the tax, he can do what is called a 1031 exchange (in reference to the Section 1031 exchange) in which he is basically trading one property for another similar property.

"The taxpayer is transferring the basis of the original property into the new place, and then deferring the capital gains tax," O'Hare says.

4. You might need to cast a broader net to find a buyer

There isn't a rule that says you have to sell your rental to the tenant. In fact, if money is your motivation for selling, you'll probably want to market your home to the broadest possible pool of potential buyers.

“Research shows you're more likely to get a higher price if your home is marketed to the public," Lerner says. "Real estate commissions[5] vary and are negotiable, but generally they run 6% total: 3% to your agent and 3% to the buyer's agent.”

Consult a real estate agent to get a good estimate of your home’s value so you can make a thoroughly researched decision on the sale.

Bishop cautions that if you decide not to sell to a tenant that you want to do so as amicably as possible.

“If the terms and price don’t work, the landlord must make certain that the tenant isn’t insulted or upset because the landlord needs the tenant cooperation to show the property to other potential buyers.”

References

  1. ^ selling a house (www.realtor.com)
  2. ^ first right of refusal (www.realtor.com)
  3. ^ rent-to-own (www.realtor.com)
  4. ^ capital gains (www.realtor.com)
  5. ^ Real estate commissions (www.realtor.com)

We've discussed the process of selling a house[1] you live in, but selling a rental property is an entirely different bird. For tax purposes, a rental house or condo is considered an investment property, which makes the sale a bit more complicated. When you sell a rental it can be subject to different taxes and rules than a standard residential sale. Read on for the essential facts.

1. Your tenant may have first right of refusal

One of the first things to understand is how local real estate laws will affect your sale. Real estate expert and author Michele Lerner says, for example, in Washington, DC, tenants have a “first right of refusal[2],” which means that landlords need to notify the tenant when they are putting the property on the market and must provide the tenant with a complete disclosure of the sales price and other information about the property.

The tenant has a specific time period during which he can respond to the landlord and either make an offer on the property or decline to buy it. After that, if the owner receives an acceptable offer from someone other than the tenant, the tenant will have another chance to match the offer or decline to buy it.

“None of this may apply in your area, but it’s important to be aware of local legislation when you sell property,” Lerner says.

2. Don't rule out a rent-to-own arrangement

Pricing is often the most difficult negotiation you'll have if your tenant wants to buy the property because he may feel that he deserves a break on the price, says Kathryn Bishop, a Realtor® in Studio City, CA.

"The tenant may want their past rent applied to the purchase price," she says. "They may also have a list of things that are ‘wrong’ with the property and want financial discounts bigger than another buyer might ask for.”

If your tenant is having trouble coming up with a sizable down payment to get a mortgage on your property, you can arrange a rent-to-own[3] arrangement with your tenant—but make sure you have an attorney write up the agreement so your interests are protected. Typically, you'd charge a bit over-market rent that you credit to the tenant toward his down payment. And the tenant could work to increase his income, reduce his debt, or save for a bigger down payment during the rent-to-own period.

3. You have to pay capital gains taxes on a rental property

When it comes to paying capital gains[4] taxes, there are major differences between selling a rental property and selling your primary residence, says Sean T. O’Hare, a CPA with O’Hare Associates in New England.

"Since a rental property is considered an investment property, when you sell the rental property you must pay capital gains on the income," O'Hare says. "A taxpayer does not receive an exemption for the sale of an investment property."

If the property was used only as rental property, then the capital gains would be calculated on the selling price less the adjusted basis of the property. The adjusted basis is the original cost less the depreciation. A residential rental property is depreciated over a period of 27.5 years on a straight line basis; basically, take the original cost divided by 27.5, and that is the annual depreciation amount.

"I usually tell my clients that they should plan on about a 22% tax to the IRS on the sale of rental property," says O'Hare.

If a taxpayer selling a rental property wants to minimize the amount of capital gains or potentially avoid the tax, he can do what is called a 1031 exchange (in reference to the Section 1031 exchange) in which he is basically trading one property for another similar property.

"The taxpayer is transferring the basis of the original property into the new place, and then deferring the capital gains tax," O'Hare says.

4. You might need to cast a broader net to find a buyer

There isn't a rule that says you have to sell your rental to the tenant. In fact, if money is your motivation for selling, you'll probably want to market your home to the broadest possible pool of potential buyers.

“Research shows you're more likely to get a higher price if your home is marketed to the public," Lerner says. "Real estate commissions[5] vary and are negotiable, but generally they run 6% total: 3% to your agent and 3% to the buyer's agent.”

Consult a real estate agent to get a good estimate of your home’s value so you can make a thoroughly researched decision on the sale.

Bishop cautions that if you decide not to sell to a tenant that you want to do so as amicably as possible.

“If the terms and price don’t work, the landlord must make certain that the tenant isn’t insulted or upset because the landlord needs the tenant cooperation to show the property to other potential buyers.”

References

  1. ^ selling a house (www.realtor.com)
  2. ^ first right of refusal (www.realtor.com)
  3. ^ rent-to-own (www.realtor.com)
  4. ^ capital gains (www.realtor.com)
  5. ^ Real estate commissions (www.realtor.com)

Enclosures

  1. ^ (realtor.com)

Authors: Street Smart REI

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