Rental properties can be a great investment, providing stable rental income and attractive property price appreciation. But for most rental property owners, there eventually comes a time when their financial and lifestyle needs change and no longer align with their property’s performance. When this happens, holding onto an investment property may no longer make sense, but when is it the right time to sell your investment property and what can you do to minimize a substantial tax bill?
To help make the best decision for your situation, here are a few insights to help recognize the personal, financial, and market-specific signals that indicate whether it is in your best interests to sell. And if you do decide to sell, learn how a tax-deferred 1031 exchange transaction can help you avoid paying gains tax and keep your investment dollars working.
Mortgage Rate Trend
After being historically low the past couple of years, mortgage rates are on the rise. With home price growth hitting extremely high levels over the past two years due to a pandemic-fueled shift in the buyer’s mindset and very low-interest rates to match, we are now starting to see interest rates climb. As a result, price growth will start to taper off, estimated to rise 4% in 2023. If you wait until the end of the year to sell, you may not be able to list the property for quite as much as you would if you listed now.
Property Demand Trend
Demand is currently high for homes and rental homes in the US. Although the rate of appreciation is most likely to slow in the coming months due to mortgage rate increases, currently, buyer demand outmatches the inventory. With a growing demand for property and limited property available as more sellers enter the market, we are set up to see home prices continuing to rise, although minimally when you compare it to the last few years.
Rental Rate Trend
Currently, there is a short supply of homes for renters. With so few vacant properties on the market, rent continues to increase, with record low vacancy rates everywhere. According to the Multifamily Outlook report from Freddie Mac, annual rent is predicted to show a 3.6% growth in 2022 across every major U.S. housing market. Rent increases are happening as vacancy rates are at a record low, largely due to the pandemic.
Amount of Equity in Property
If your investment property was acquired years ago and there’s been a substantial price appreciation since then, it may be the perfect time to consider selling. There’s no debating that home price growth has been high in recent years, and it may very well be the case that cashing out and accessing your equity now will earn you maximum profit.
Quality of Reinvestment Options
Home price growth has been significant in recent years, and you might be looking at your rental property thinking that if you sell now, you can reap the profit of substantial price appreciation. However, using those funds to purchase another rental property may not go as far as you hoped. As the buyer, you are dealing with a seller’s market, meaning high-priced property. In addition to that, you will have to pay capital gains tax from selling. A great sidestep to reduce or even eliminate tax liability while continuing to receive passive income is a 1031 exchange. You may be able to find a higher-quality reinvestment option as you’re not dealing with the multifamily housing market. In addition to that, you are not losing a percentage of your profit to tax.
Maintenance and Repair Costs
Is maintenance too much of a headache? Does the property need substantial repairs to be competitive in the market? When deciding whether to sell your rental property, there is more than just finances to consider. Does this investment make sense for you and your current circumstances? There are non-financial impacts to consider as well. Dealing with tenants and maintenance issues as a landlord may be more hassle than you are looking to continue taking on.
Pending Lifestyle Changes
Similarly, a lifestyle change could prompt your interest in stepping away from your rental property and the active management that goes with it. Does owning and maintaining the rental home still align with your lifestyle? Are you hoping to retire earlier than planned? Or do you simply find yourself too busy to manage your investment property? Investing in a property that lets you switch from active to passive management may fit your lifestyle better.
Fully Depreciated Investment Property
A great time to think about selling your rental property is when depreciation benefits run out. Depreciation is a non-cash, capital expense that every rental property owner can take to recover the cost of their income-producing property through tax deductions. If you have held on to your rental property for longer than you have been able to depreciate, selling could be in your best interest. Depreciation is all about saving money through taxes, but if your benefits have run out, selling your rental property and investing in a 1031 DST replacement could prove more financially viable.
Tax-Deferred 1031 exchanges offer many benefits and options. However, the primary benefit is the deferral of taxes resulting from the sale of investment property, which can be significant. Being able to defer tax means more of the net proceeds can be reinvested into a more favorable location and type of replacement property, immediately positioning the owner for even greater income potential.
Landlords can also use a 1031 exchange to transition from properties requiring active management to investment real estate that can generate passive income, like management-free 1031 Delaware Statutory Trust properties.
Real Estate Transition Solutions is a consulting firm specializing in tax-deferred 1031 exchange strategies and Delaware Statutory Trust investments. For over 26 years, we have helped investment property owners perform strategic 1031 exchanges by developing and implementing well-planned, tax-efficient transition plans carefully designed to meet their objectives. To learn more about Real Estate Transition Solutions, call 888-286-5395, or visit our website at www.re-transition.com/aoa.
IMPORTANT INFORMATION: The information herein has been prepared for educational purposes only and does not constitute an offer to purchase or sell securitized real estate investments. Such offers are only made through the sponsor’s Private Placement Memorandum (PPM), which is solely available to accredited investors and accredited entities. Case studies and examples are for illustrative purposes and not representative of future results. There are risks associated with investing in real estate properties, including, but not limited to, loss of entire investment principal, declining market values, tenant vacancies, and illiquidity. Because investor situations and objectives vary, this information is not intended to indicate suitability for any particular investor. This material is not to be interpreted as tax or legal advice. Please speak with your own tax and legal advisors for advice/guidance regarding your situation. DST 1031 properties are only available to accredited investors (generally described as having a net worth of over $1 million dollars exclusive of primary residence) and accredited entities only. If you are unsure if you are an accredited investor and/or an accredited entity, please verify with your CPA and Attorney. Securities offered through Aurora Securities, Inc. (ASI), member FINRA/SIPC. Advisory services offered through Secure Asset Management, LLC (SAM), a registered investment advisor. ASI and SAM are affiliated companies. Real Estate Transition Solutions (RETS) is independent of ASI and SAM.