You bought your investment property for the sole purpose of making money. But the profits should still roll in once you decide to part with the property and sell it. When it comes time to list your investment property for sale, getting the most money out of the deal is most likely where your focus is.
While selling an investment property is somewhat like selling your home, there are a variety of capital and tax issues that can make this type of sale more complex.
Here are some things to consider in order to make the most money when you sell your investment property.
Make Sure Now is a Good Time to Sell
Before you list your property, make sure you’ve considered all avenues to determine whether or not it’s a good idea to let go of it. There are all sorts of reasons why you might want to sell, such as freeing up some capital to take advantage of a better investment, getting out of a declining neighborhood, or dropping down a notch on the tax bracket ladder.
If you’ve held onto your investment property for a long time, odds are it has greatly increased in value. As such, you can probably make a hefty profit and take those monies to branch out and diversify your real estate investment portfolio with other investment properties.
Whatever your reason might be for wanting to sell, you need to be aware that there are major tax issues that you will have to contend with that could take a chunk out of your profits. Just make sure you’ve crunched the numbers to make sure you don’t walk away in the red.
Attract the Right Buyers
Other real estate investors are the obvious target when it comes to marketing your investment property for sale. However, there may be other types of buyers out there that may be interested in the property. You may have been using it to bring in a steady income through rent, but you may be able to attract a variety of other types of buyers.
Some buyers may be interested in living in one part of the building while renting the other part out to help with the mortgage. Or perhaps the renters who are already living in the unit might show interest in becoming owners themselves, in which case your potential buyer is right under your nose. Your real estate agent will be able to help you diversify your options when it comes to marketing the property for sale so you can attract as much interest in it as possible and draw in a solid offer.
Understand Capital Gains
When you sell an investment property, you’ll be slapped with a capital gains tax bill that you’ll have to pay, which is a lot more than the taxes you would have to pay upon the sale of your primary residence. Essentially, capital gains refers to the profit you make from the sale of your investment property, which will be taxed. For instance, if you sold an investment property for $500,000 and you originally bought it for $400,000, you would make a $100,000 profit, which is what would be taxed.
Any depreciation that you claimed against the property will cause the basic capital gains to increase. That means that if your investment property lost money while you owned it and you used such losses to reduce your tax bill in the past, your capital gains taxes will be higher once you sell. Using the above example, if you deducted $40,000 in depreciation during the time that you held title on the property, that $40,000 would be added to the $50,000 profit, and you would therefore be taxed on $90,000 instead of $50,000.
Capital gains taxes are also affected by how long you’ve held onto the property. If you’ve owned it for less than a year, the property would fall under the short-term capital gain category, which means it would be taxed like income. However, if you owned the property for more than a year, it’s considered a long-term capital gain, in which case it would be taxed at a lower rate.
Avoiding Capital Gains With a Rollover
There is a way to avoid paying capital gains on the profit you make upon the sale of your investment property, and that’s by putting the proceeds of the sale directly into escrow that will be used to purchase another investment property. IRS Section 1031 allows this tax deferral, which could save you a pretty penny come sale time. This 1031 exchange of similar properties is a strategy that you can use repeatedly with no limit, so you can essentially trade similar properties as many times as you like while expanding your investment portfolio on a tax-deferred basis.
It should be noted, however, that there is a 45-day time limit that these proceeds can sit in escrow before being put towards a new property. This type of arrangement needs the expert assistance and advice of a seasoned lawyer and/or tax advisor to set up.
Setting Up an Incorporation to Take Advantage of More Favorable Tax Rules
More and more real estate investors are looking at incorporating in order to reduce their personal liabilities and pay fewer taxes upon the sale of an investment property. If you’ve hired property managers to help you handle your portfolio of income-producing properties, incorporating can reduce the amount due for taxes when you sell. Any profits made will be funneled through your corporation.
However, you won’t have easy access to any monthly income coming in from you investment property if it’s under your corporation. If you rely on that monthly rental income for any reason, an incorporation may not be ideal.
The Bottom Line
The return you receive come sale time will depend on how much the property has appreciated in your market, how long you’ve owned the property, how much you have left on the mortgage, and so forth. Selling an investment property is a more complex and intricate process than simply selling your residential home. From specific marketing tactics, to maintaining compliance with the IRS, to avoiding having to pay more taxes than necessary, the sale of your investment property should only be done with the right help enlisted. Done at the right time and with the right tactics, there’s little reason why you shouldn’t realize a sizeable profit upon the sale of your investment property.