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Want to Sell Your Property? Here Are Some Exit Strategies

Want to Sell Your Property and Exit Real Estate Investment?

As much as I’d love to keep every rental I buy, forces out of my control may require me to sell my property early. But whether it’s new legislation, a declining neighborhood, or a strategic plan to move up to a better investment, determining how to exit that real estate investment is something you should consider. Here are a few options for you to consider and some scenarios where they can be most beneficial.

Getting Into Real Estate Investing

At our company, we focus quite a bit on how to get into the real estate investing game. We do our best to teach you how to prepare yourself to invest by credit preparation, financing options, and legislation to pay attention to before you buy. We also teach you to look for the property that best fits your goals and lifestyle.

Furthermore, we all have different cash reserves and time constraints, making our investment choices different. Of course, once you buy that great asset, we cover how to manage it so it continues to produce the highest return for your investment.

All that said, we are looking at a vital aspect of keeping your investment portfolio on track with your financial wellness goals: your exit strategies. What happens when you decide to get rid of one of your properties? As with anything real estate-related, numerous financial implications have the potential to make you money or cost you money.

Understanding Exit Strategies in Real Estate

By the end of this blog, you will better understand each of these strategies and be better equipped to choose one in the future as you consider the necessary changes to your investment portfolio.

Selling Your Property

Listing the property for sale is by far the most straightforward option. Hire an agent, get a market analysis of the price, and sell it. Unfortunately, this will also be your most expensive option.

As with any sale, you are looking at commissions, title fees, and possible repair costs that might surface during the transaction or before as you get it ready for sale. Depending on the market that your property is located in and the type of property you are selling (entry-level homes), you might also need to chip in some closing costs to help the right buyer close the deal.

Tax Implications of Selling

It is no secret that Uncle Sam likes to take his cut on any gains you’ve made while you owned the property. Your pay will depend on how long you have had the property. If you owned a fixer-upper for one year or less, you are subject to short-term capital gains taxes, arguably the highest.

In essence, you are getting taxed at ordinary income tax rates. These are the federal rates for 2024:

Keep in mind that you are subject to state taxes as well. If you’re making $45k a year and another $30k in capital gains, just about $30k will be taxed at the 22% rate. (You’re paying more for capital gains than your income.)

Holding the Property for Long-Term

There is some relief in sight if you hold the property for over a year. At that point, selling it would subject you to these more favorable tax rates. At most, you stand to pay a flat 20% if you’re in the highest earning bracket.

During the writing of this blog, President Biden has a new budget proposal that will impact how capital gains are taxed.

Needing Full Equity from Property

Despite the higher cost, selling a property outright might be necessary if you need the total equity from that property. If you have more time to plan this exit, you might be a good candidate for this next option.

Moving into the Property for Two Years

If you have time to move into your rental for at least two years, which by the way, do not have to be consecutive, you can take advantage of the home sales tax exclusion offered by the IRS.

In layperson’s terms, every homeowner can claim up to $250,000 in capital gains per single filer and up to $500,000 for married couples from the profit of their residence. If you and your spouse bought a home for $100,000 and sold it for $500,000, so long as you lived in it for at least two years, you would pay $0 on the $400,000 profit you made. Excellent deal, right?

Details to Keep in Mind

Of course, there are a few details to keep in mind.

First, this only applies to your ‘home,’ which begs the question, do you have two years to spend in this house?

Two, do you even want to live in that house? I do my best to keep this in mind when I consider properties I buy. Can I live there if I had to?

Third, you can’t take the exemption if you bought this rental as part of a 1031 exchange since capital gains have already been deferred. Uncle Sam says, “It’s time to pay the piper.”

Example Scenario

This fourth one is a little tricky. If you took an exemption on another home within the last two years, you would not qualify again on this property if you lived in it for two years with time in between, so not consecutively. Here’s how that might happen:

You live in your home in California for two years, then move into your rental in Nampa, Idaho for one year. You move back to California because you can’t cut the winter here and live there for another year. You realize that California laws and politics have worsened since you’ve been gone, so you decide to cut ties and return to Idaho to brave the minor snow. You sell that home in CA and claim the home sales tax exclusion on that profit, paying zero capital gains tax. Yay, you!

Back to the Rental

You move back into your rental and live there for a year before you realize it’s got the makings of a rental, not your home. So, you decide to buy another house and sell this rental property. You think you can get another capital tax exemption because you lived in that rental for at least two years.

Nope! The IRS says no go. You can only take one exemption per two years. After you visit the tax advisor, you call the realtor to take it off the market. Then, you move into it while building a new home that you move into after living in this rental for another year. Later, you sell that rental, and now you can take that exemption. Tada!

Importance of Appreciation

Yes, it’s quite a bit of work. However, with the appreciation numbers we have seen in the last ten years, saving yourself some serious money might be worth it as you exit a property or even a real estate investment portfolio.

1031 Exchange for Another Like-Kind Property

Your reason for exiting from a specific property may have something other than your need for immediate money or even getting out of the real estate game. The exit for a specific property may be the cost of entering into a much more profitable venture.

If you are in growth mode and want to increase your cash flow or net worth (or both), consider a single-family rental for a fourplex. Selling that $300,000 home and buying a $700,000 fourplex would likely increase your net worth faster than a single-family home.

Mitigating Costs with 1031 Exchange

As mentioned previously, selling your property will carry a lot of costs, including fees and taxes. Doing a 1031 exchange can help mitigate the tax portion, which might be the more extensive expense.

Currently, the IRS allows you to defer any taxes owed on the sale of a property if you use the proceeds to buy another one. As with anything the government allows, there are essential 1031 exchange rules to adhere to:

1. New Property Is of Higher Value

First and foremost, your new property needs to be of equal or more excellent value than the property you’re selling. Failing to meet these amounts can result in taxes owed despite the 1031.

2. You Follow Strict Timelines

Second, timelines matter. You have 45 days to identify a new property and 180 days to close on it. Not doing either within the strict timelines will make deferred taxes impossible.

3. Use a Third-Party Mediator

Third, you cannot touch any of the money. Usually, in 1031 exchanges, you have a third-party mediator. In some parts of the world, we use a 1031 accommodator through our title companies. This third party is in charge of handling all the money. They ensure that the timelines are met and that any funds not invested in the new property is reported correctly for capital gains taxation.

Refinancing for an Infinite Return

What if you want to have your cake and eat it too? Real estate has appreciated quite a bit recently. If you were lucky enough to have purchased real estate in our Boise Metro Area even in the last five years, your investment would have accumulated significant appreciation.

If you know how appreciation, debt reduction, and equity all play together, you know that the more your property appreciates, the more equity you have. And equity, my friends, translates to money in your pocket when you sell or refinance a property.

Example of Refinancing

If you wanted to buy another property to grow your real estate portfolio using the equity you had accumulated in your current rental, a sale of that property might not be necessary if you could do a cash-out refi to pull out your invested capital. Then, you can utilize that money as a down payment on your next purchase.

Another Scenario

Let’s look at some numbers as an example. Say you bought a property here at the end of 2016. Just in time for Snowmageddon — lucky you! Let’s stick with averages for easy comparisons.

If you bought the average priced home, it was right around $255,000. It would have appreciated about 9% just in that first year. Then, another 16.9% in 2018, and more each year until today. Even with that slight 3.1% dip in 2023, you would be looking at a property now worth about $604k!

That is an appreciation growth of $349K in just those eight years. Clearly, any money you invested in the property could be easily recouped through a sale or refinance. Refinancing that property to take out your initial investment would give you an infinite return. You earn an infinite return on anything where you continue to make money through cash flow or appreciation despite no longer having any money invested in the property.

Risk Reduction

Although you are not technically exiting from this property, your risk of losing money on that property has been eliminated.

Offering Seller Financing

Sometimes, you are tired of managing a property and want to sell, but you want to avoid paying the capital tax gain or moving into the rental for two years to prevent said taxes. So what do you do? Consider becoming the bank and carrying the note for your buyer.

 

Offering seller financing on a property you own free and clear can minimize the taxes you have due at once while removing your responsibilities to maintain that property. Still, there are instances when you can do this while still having a mortgage, called Subject To. (More on that another time.)

Structuring the Contracts

There are many ways to structure the contracts in these sales, but the most common I have seen is for the seller to include a straightforward carry-back note.

The seller collects a down payment, and the balance is paid back within a certain term at a specific interest rate with a balloon payment due normally at some point, say five or ten years. Remember, when you sell, your capital gains rate is dependent on your income as well. A big chunk of money realized by a straightforward sale can throw you into the higher tax bracket.

Conversely, if you only claimed a portion, say the down payment on a seller carry-back transaction that first year, and whatever is paid off yearly on the other years, you can spread that tax expense over the years you finance that property. Meanwhile, since you transferred that ownership, you are no longer on the hook for maintenance, taxes, insurance, and any other costs associated with owning that property.

Risks of Seller Financing

Of course, as with any loan, there are risks. Banks take a risk on you when they lend you money, and you are taking a risk on that buyer when you “lend” them money to buy your house.

Like how the banks put up the home as collateral, you would do the same in your transaction. If your buyer defaults, you will have the expense of evicting them and foreclosing. But at the end of the day, you will get your property back and sell it to the next buyer.

Depending on your situation, you can change your sales approach. Maybe you do a straight sale and just take the tax hit. Or you could hire a property manager and rent it out again.

Conclusion and Considerations

  1. Market Conditions: Current real estate market conditions can significantly affect your selling price and the time it takes to sell.
  2. Tax Implications: Capital gains tax, depreciation recapture, and other tax considerations should be evaluated by a tax professional.
  3. Costs Involved: Consider expenses such as agent commissions, closing costs, and potential loan prepayment penalties.
  4. Legal Implications: Ensure compliance with all legal and contractual obligations related to the property and the sale process.

Consulting with a real estate professional (that’s me), financial advisor, and tax advisor can provide you with a more personalized plan for your specific situation and investment goals. If you need assistance, please contact us directly.

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