Whether you’re exploring options or have decided to list, selling a rental property in California doesn’t have to be a stressful experience.
Rental property owners that are more prepared, tend to have a smoother selling process.
This means you should familiarize yourself with:
- Your investment properties local and national real estate trends
- Obtaining and organizing your financial documents
- How to prepare your home for a smooth rental property sale
- Handling Tax liabilities from the proceeds
This guide will focus mainly on number 3 and 4.
We’ll cover:
- Common reasons landlords decide to sell their rental properties
- How to prepare your property for the market
- What to expect when selling your rental
- And strategies for limiting your tax liability.
Feel free to use the Table of Contents below to jump around.
Does Selling Makes Sense?
Many real estate investors intend to own their investment property for several years or even decades. This buy-and-hold strategy creates a revenue stream from rental profits while also allowing the property value to appreciate.
Waiting, though, is not always the best option.
Eventually—sometimes sooner than later—market conditions or personal circumstances force you to sell rental property despite market conditions.
1. The property is no longer profitable
The point of an investment property is to generate income. When the property no longer serves that purpose, it may be time to sell.
For example, has your property become more expensive to maintain than it’s earning?
If so, selling allows you to cut your losses and exit the property. If you sell at a loss, you can also deduct the amount from your taxes.
Remember, however, that a rental property doesn’t necessarily become profitable overnight. Consider performing repairs and advertising the property to attract high-quality, responsible tenants.
2. The property needs extensive repairs
Depending on the extent of the needed repairs, it may make more financial sense to sell the property if it needs repairs.
For instance, some repairs cost thousands of dollars. These include repairing an outdated roof, replacing a malfunctioning HVAC system, or repairing structural damage.
If the cost of repairs outweighs the profits from rent, it’s time to sell.
Deferring maintenance to the next owner typically reduces the sale price of the property. Nonetheless, this discount could still offset your repair costs and allow you to break even or sell at a minimal loss.
3. The housing market has changed
Changing market conditions may prompt you to sell a rental property in California. Like almost every other major real estate market, the housing market in California has boomed in recent years.
Because of the degree to which demand has outpaced supply, it’s a seller’s market. This inventory crunch has resulted in homes selling after less than a week on the market and sellers receiving offers well over the asking price.
Selling now may lead to a greater immediate profit than holding onto the property for the long-run. This is particularly true if you have established significant equity in the property. As home prices continue to increase, your equity will also increase.
It may behoove you to sell before a potential market crash.
4. The local housing market has changed
These national housing trends may not necessarily apply to the local market in which your rental property is located.
Although California’s housing market generally continues to thrive, this is not true of certain rural areas. Slower job or population growth reduces demand and increases the difficulty of finding a tenant at the price point you seek.
Similarly, an increase in new construction will further depress demand.
5. The national economy has lagged
Similar to a property whose needed repairs outweigh its current rental value, rising interest rates will eat into your rental profits if you financed your property.
The nation continues to deal with the pandemic-era economy and rising inflation. This has led the federal government to announce a rise in interest rates. Many economists expect rates to continue to rise.
If you financed your rental property, stay wary of the changing rates. This increases your mortgage payment to the extent that renting the property is no longer profitable.
While the housing market continues to boom, you may want to sell before rising interest rates depress home values.
Stressed about selling your rental?
Selling a rental in California can be stressful especially with
uncooperative tenants. If you want to sell without the stress, hassle
and headache of listing, Realtors and dealing with Tenants we can help!
Receive a guaranteed all cash offer within 48 hours and close on your
home within 7 days. You may be one click away from your next business venture.
Preparing the Property for Sale
If you have determined that selling your rental property in California is the best move, the next step is to prepare for the sale. This includes conducting your own due diligence, organizing financial documents and information, and providing notice if you have a tenant occupied property.
1. Identify the Target Buyer
Owning a rental property creates a unique opportunity when looking for potential buyers. Selling to a real estate investor, the current tenant, or another buyer looking for a primary residence are all options.
Your target buyer may affect your pricing strategy. For example, a tenant who already lives in the house may be less likely to pay above the market rate because they know what they’ll be getting into.
On the other hand, you may make more money by selling to another investor who sees the potential of the property.
1. Selling to the Current Tenant
If you already have a trustworthy or quality tenant, consider whether they could afford to purchase the property. Selling to a known buyer reduces the stress of the process and can negate the need for hiring a realtor.
2. Selling to Another Investor
On the other hand, another real estate investor may want to purchase your property. If the current tenant doesn’t want to buy the home, use the fact that the property is already leased to a quality tenant as a selling point. While this won’t necessarily increase the rental property’s sale price, it is a marketable point to investors seeking a turn-key property.
Other real estate investors will want to know:
- How long the tenant has rented the property
- The monthly rent
- Whether rent is paid on time consistently
- Who pays utilities
- When the lease expires
- Whether there are any security deposits, permits, or licenses involved with the lease
- The degree to which the tenant maintains the property
Marketing to other investors requires a different strategy from marketing to other buyers. Rather than constant showings that disrupt the tenant’s life, you can do this process online. Better yet, investors buy houses for cash and can typically close faster than a traditional sale.
3. Selling to a Home Buyer
In a thriving housing market, selling to a buyer searching for a primary residence may yield a larger profit. While it may sound appealing to cut costs by selling the property yourself, hiring a realtor brings in a 6% higher sale price on average.
For rental property, consider finding a real estate agent with access to:
Rent trends in your areaTax implications of selling a rental propertyReturn on investment analysis toolA network of real property investorsAfter-repair value (AVR) analysis tool
2. Prepare the Tenant
With a good tenant selling a rental is easy. With a bad tenant it’s a challenge. Most tenants tend to fall in between. So when selling a rental property with an existing tenant, subject to a lease agreement, you’ll want to assuage any concerns they have regarding the sale to have the smoothest transaction possible.
The Lease
If the tenant isn’t in a position to purchase the property, you must honor the terms of the tenant’s lease. Your current tenant may wish to continue the lease. In that case, the lease will transfer to the property’s new owner. The new owner will have responsibility for collecting payment, returning any security deposit, responding to maintenance requests, and any other related duties.
Where a lease is near its termination date, you’ll still need to provide notice to the tenant. For a periodic or month-to-month lease, you must give tenants 30-days’ notice. For a tenant who’s rented the property for a year or longer, you must provide 60-days’ notice.
Otherwise, you may choose to incentivize the tenant to vacate the property before the lease ends. An incentive may look like discounted last month’s rent, deposit assistance, or relocation assistance.
Showing the Property
With a tenant who remains in the home while it’s on the market, it’s important to maintain a positive relationship. This is because you’ll want the home to be presentable and the tenant to vacate for any showings.
You may provide a non-disruptive showing schedule or provide incentives like weekly cleanings or gift cards for cooperation.
3. Prepare the Property for Sale
To market the property effectively and attain an appropriate sale price, you should be aware of all of the property’s pros and cons.
1. Obtain a Pre-Listing Inspection
Whether you hire someone to perform an inspection or not, the buyer most definitely will.
By obtaining a pre-listing inspection, you can learn of all necessary or recommended repairs. Depending on their extent, you can choose which (or all) repairs to perform.
Consider:
- The real estate market: A low-inventory seller’s market with few properties at your desired price point may lead you to perform only the most necessary repairs. You could also discount the property rather than provide extensive construction. But for those repairs you do perform, the cost is tax-deductible. , this includes costs for repairs that are “expenses [necessary] to keep your property in good working condition but that do not add to the value of the property.”Improvements or updates are taxed differently.
- Whether tenants will remain in the property: If any repairs require an empty house (i.e., fumigation or roof replacement), you may need to wait until the current lease ends.
2. Conduct a Lien Search
For rental properties which are financed, you need to conduct a lien or title search. While the lien search will reveal your mortgage, it will also show whether any unknown liens (e.g., a mechanic’s lien) encumber the property.
An escrow officer can perform this search for you.
Stressed about selling your rental?
Selling a rental in California can be stressful especially with
uncooperative tenants. If you want to sell without the stress, hassle
and headache of listing, Realtors and dealing with Tenants we can help!
Receive a guaranteed all cash offer within 48 hours and close on your
home within 7 days. You may be one click away from your next business venture.
4. Gather Essential Documents
The documents necessary will depend on your buyer. However, a real property investor will perform their own due diligence.
An investor will also seek:
- A copy of the current lease
- A record of the current security deposit
- Recent utility bills (if paid by the landlord)
- Recent history of maintenance requests up to the current year
- Reports of any insurance claims dating up to five years
- Current and previous property tax bills
- Homeowner’s Association (HOA) documents and financial statements
- Seller’s tax returns (used to compare reported rental income with IRS records)
An investor may also seek information regarding the rental property’s recent financial performance as reflected in the following reports:
- Income versus expenses
- Capital expenditures
- Net cash flow
- General performance
A comprehensive financial management system, such as a smartphone app or computer program, can provide such reports.
Tax Consequences of Selling Rental Property in California
No matter to whom you sell your rental property, you must consider the tax consequences. For investment property, you may have to pay a capital gains tax and depreciation recapture tax.
However, it is possible to limit your tax bill.
Depreciation Recapture Tax
As a real property investor, you may claim a depreciation tax break during the years in which you rent out the property. For each applicable year, you can reduce your taxable income by subtracting the amount by which your real property depreciated each year.
When you sell a rental property, the IRS will recapture this tax break by requiring you to report as ordinary income the difference between the sale price and the adjusted cost basis of the property. This annual amount is then added together and taxed at your normal income tax rate (but capped at 25%).
Depreciation Example
Imagine you purchased a property for $500,000 that then sold for $600,000 five years later. During that five-year period, assume the property depreciated at an annual amount of $18,182.
This results in $90,910 over the five years. If your income is taxed at 22%, for example, then you would owe about $20,000 in depreciation recapture taxes.
A “tax on the sale of real property” calculator is helpful.
Capital Gains Tax
In addition to the depreciation recapture tax, you will also be assessed a capital gains tax. The capital gains tax is assessed on the amount by which you profit from the sale of the property.
The applicable rate depends on how long you’ve owned the property. If you’ve owned it for less than one year, this profit is taxed at your ordinary income rate—anywhere from 10% to 37%.
When you’ve held the property for longer than one year, the profit is taxed from 0% to 20% depending on your income and filing status. This is a significant difference that can help you avoid high tax liability.
For tax filers who earn between $78,750 and $488,850, the long-term rate is 15% while for those who earn over $488,851, the long-term rate is 20%.
Capital Gains Tax Example
Using the example above, imagine you’ve owned your property for two years when you decide to sell. Because you sold at $600,000 and bought at $500,000, your gross profit is $100,000. Assume your tax rate is the higher 20% for long-term capital gains. This results in a $20,000 tax.
Limiting Tax Liability
You may ask yourself, “How to sell a rental property without paying taxes?” While eliminating all taxes may not be possible, there are ethical methods of limiting your tax liability.
§ 1031 Exchange
Rather than pay depreciation recapture and capital gains taxes after the sale of your rental property, you can defer these taxes to a future date by using what’s known as the § 1031 exchange.
This strategy takes its name from a section of the Internal Revenue Code—§ 1031. To take advantage of the § 1031 exchange, the following rules apply:
- You must purchase a property of the same “like” or “kind” – it must be another investment property you intend to rent out or flip.
- Within 45 days of closing on your current property, you must identify the replacement property. You may choose up to three properties.
- Within 180 days of the closing, you must close on the replacement property.
- General performance
If you use a “qualified intermediary,” then the IRS will consider your purchase compliant.
The exchange allows you to defer paying capital gains and depreciation recapture taxes until you sell the newly obtained property.
Learn More: Handling Taxes on the Sale of Your Rental Property
Pass the “Ownership and Use” Test
If you sell a rental property that was your primary residence, you can reduce your capital gains tax. To take advantage of this tax break, you must:
- Own the home for at least 2 years
- Live in the home as your primary residence for at least 2 out of the last 5 years.
The amount of the reduction depends on your filing status. For single filers, you would owe no capital gains taxes on a $250,000 profit while those married filing jointly would owe no taxes on a $500,000 profit.
Is Now the Time to Sell?
If you’ve decided that selling your rental property is the best course of action for your portfolio, SoCal Home Buyers is here to help. With this red-hot housing market and rising interest rates, the time to sell could be now.
Our specialists can help you determine if selling your current property quickly, limiting your tax liability, and moving on to your next project is right for you. The best part is you can close without the headaches of real estate agents, fees, closing costs or repairs.
Contact SoCal Home Buyers today for a fast, simple and painless real estate transaction.
