As a property investor, you know that there’s a time to buy and there’s a time to sell.
That’s true even with rentals, where buying and letting sit to collect rent is the norm.
Whether it be due to a change in life circumstances, goals, investment strategy, or you’re doing a 1031 exchange to purchase a new rental, selling a rental property can be tricky.
- Navigating ongoing lease terms
- Potential repairs
- Tax rules
And more to contend with– not to mention the work that goes into advertising and selling the property.
Let’s start with how to actually properly sell a rental property first.
If you have a current lease going with a tenant, you need to go about things in one of a few specific ways to not break local rental laws.
But don’t fear, you’ve got options.
And stick around later as we’ll also be going over how to avoid capital gains tax from the sale of the property as well.
How to sell a rental property: 4 Methods
If you have an ongoing lease with a tenant, you can’t just up and sell your property unless you have an early termination clause.
If you don’t have that within your lease, there is no easy option.
That might be disappointing news, but fortunately, there are still a few ways you can sell the property.
The four main methods you can use to sell your rental property include:
1. Pay your tenant to vacate
When you’re looking to sell a property that has an active lease, the crux of the issue is that you need to do something with the lease itself.
Your first option is to encourage your tenant to leave the property by offering to pay.
How exactly does that work?
You negotiate a settlement with tenants where you pay part or all of their moving costs. In exchange, they agree to exit their lease so you can sell the property.
Consider these costs before calculating how much to offer:
- Security deposit: The most obvious expense, the security deposit is the main thing you should offer to pay for.
- Rent increase: You could offer to pay the difference in rent for an equivalent number of months as is remaining on their lease. If they’re currently paying you $1200 but the property they choose is $1350, you’d be $150 x the number of months left on their lease.
- Moving expense: Will they need to pay for a moving truck? Movers? Offer to cover this expense as well, which typically is a fraction of the above-mentioned expenses but serve to be an attractive benefit nonetheless.
Keep in mind, however, that these combined costs can become steep.
Make sure you know in advance how much you’re comfortable offering as an incentive to encourage your tenant to move, so you don’t go beyond it.
2. Wait until your tenant’s lease expires
Arguably the simplest but often least preferable option, you can always wait until your tenant’s lease expires to make the sale.
In this scenario, you’d simply wait out the lease then properly notify your tenants of your intent to sell so they’re aware in advance.
This likely isn’t the option you want to use, especially if you just started or are in the middle of a lease term.
However, every other option on this list takes either extra effort or money.
So, the main question you need to ask yourself is which you’re more willing to give and give up: time, effort, or money.
Just keep in mind that waiting to sell could also cost you money given the market could change from now until then.
3. Find a buyer to purchase the property with the lease
This is another viable option, particularly for those looking to save cash and time.
Where the first option costs money and the second time, this option is more effort-based.
It’s not necessarily fast, though, as you’re strictly looking for investors interested in buying who are also willing to take on a lease and existing tenants.
It will take time to find a buyer willing to take on your lease with no guarantee you’ll find one before the lease is up.
However, if you put your documents together right and can show that the property has a lot of opportunity, you could find a buyer relatively quickly.
4. Sell to your tenant
A final option is to sell the property to your tenant.
This one is the rarest and least likely as the tenant needs to:
- Have an interest in purchasing the property, and
- Be in a financial position to do so
Having said that, if those two things align it can be a great option for both you and your tenant as it means:
- They don’t have to go through the trouble of moving, and
- You don’t have to look for a buyer
If your tenant has been great and you’ve loved working with them, that’s a good sign to consider this option.
Chances are they’re responsible with their greater financial situation if they’ve been responsible with rent.
Plus, having had a positive experience living at the property they’ll be more likely to consider purchasing it.
As a last but important note: No matter which option you decide to go with, make sure to double check your state’s rental and tenant-specific laws to make sure you’re following all necessary guidelines.
Steps to take before selling your rental property
Now that you have a better idea of the routes you can go to sell your property, let’s talk about steps to take before selling.
Identifying your target buyer is the first and most important step, but there are a few more you can take to smoothen the process, especially if this is your first time selling a property.
1. Get a pre-listing inspection
A pre-listing inspection is simply an inspection you complete before listing the property.
This is useful for two reasons: it allows you to accurately estimate the value of the property while also ensuring the purchase process goes smoothly.
That’s because you’ll already have caught any potential repairs ahead of time.
2. Complete repairs
You could put these off until the purchase inspection and see what your buyers want, but it’s generally best to get these done beforehand.
This helps your property look better to potential buyers, who don’t think like investors or flippers.
They don’t want to have to deal with repairs the moment they purchase the property unless they’re going in wanting a fixer-upper.
3. Set a price
Now with inspection in hand, consider how you’ve chosen to sell the property to decide on a price.
You’ll typically be able to get more from an investor with an existing tenant as they’ll immediately be able to collect rent.
On the other hand, a standard sale or one to your tenant should usually be set at a comparable price to recent sales nearby of similar properties (like usual).
Either way, it’s important to know how much you should be charging so you can get the most from the sale while also ensuring the sale doesn’t take longer than expected due to overpricing.
4. Communicate with your tenant
Let your tenant know in advance that you’ve decided to sell and are preparing to show the property.
Make sure they understand exactly what is going to happen depending on how you’re selling it.
For example, if you’re selling to an investor and transferring the lease, explain how their lease and security deposit is going to transfer to the new owner and reassure them that the process will be smooth.
Also, make sure to work with them as much as possible during showings by finding days and times that work best for them while intruding as little as possible.
Tips for handling taxes when selling a rental property
When selling a rental property, it’s important to understand the potential tax consequences.
Paying taxes on the sale of a property isn’t surprising, but the potentially hefty capital gains taxes you often pay when selling a rental property can be.
That’s because the sale of a rental property is much different than that of the sale of a primary residence.
When you sell a primary residence– a property to which you’ve lived in for two of the past five years, typically– you don’t usually pay taxes on the sale up to a certain amount.
However, if selling an investment property, you’ll pay capital gains tax on the property’s growth.
How much you pay typically depends on how long you’ve owned the property.
If you’ve owned the property for one year or less, you’ll usually pay short-term capital gains tax at a rate somewhere between 10-37%.
If you’ve owned the property for more than one year, you’ll pay anywhere from 15-20% unless your taxable income is below a certain threshold.
So then, what are your options?
There are a few, but the one most often used and most accessible is a 1031 exchange.
How a 1031 exchange helps you defer capital gains tax
A 1031 exchange allows you to defer capital gains tax on an investment property, making it the perfect tool when selling your rental property.
The only caveat to that is you need to intend to use the proceeds from the sale for further investing.
With a 1031 exchange, you’re able to avoid paying capital gains tax by essentially exchanging one property for another:
If you’re trying to exit a rental property and use the funds for another venture or simply to cash out, this isn’t an option.
However, it’s great if you’re trying to shift from one neighborhood or property to another more potentially profitable one.
The main stipulation of a 1031 exchange is that it must be a like-kind property.
To put it simply: the property you intend to purchase needs to be similar in certain ways to the one you want to buy.
For example, you can’t exchange a rental property for one you intend to be your primary residence.
There’s more to it, but suffice it to say that you’ll want to exchange the property for another of similar or lesser value for the same purpose (use as a rental property).
Want to learn more about 1031 exchanges and how they work? Read:
- IRS 1031 Exchange Rules for 2022: Everything You Need to Know
- 1031 Exchange Timeline: How the IRS 1031 Exchange Process Works
- 1031 Exchange Rules in California: What You Need to Know
- And learn more about how rental income tax works: How Rental Income Tax Works (+ Tips for Reducing Tax Burden)
Selling your rental property doesn’t have to be difficult
When it comes to selling a rental property with an active lease, there is no easy way out.
However, if you’re aware of the tools available to you the process becomes much easier– and more profitable.
If a 1031 exchange sounds like the right route for you to take, check out our complete guide to 1031 exchanges to see if it’s the right move for you.