There are really three ways to sell your rental house. When it comes to selling a rental property, there are several things to consider. Figuring out in what condition you want to sell your property is just the beginning. You’ll also want to consider the taxes associated with your sale, especially capital gains tax.In this article, we're going to take a closer look at how to sell your rental property and the taxes associated with the sale. We’ll also identify different ways you can go about avoiding some of these hefty taxes when selling rental property.
Selling a Rental Property
There are three primary ways to consider selling your rental property: selling it as is, with a resident in it, and renovating.
1. Selling As-Is
Once the resident moves out, and before you do any repairs, there’s a market out there for houses that will sell as-is. There’s a market for houses that need work, and you can move a resident out and sell it to that market. You’ve seen we buy ugly houses, people, you’ve seen we buy houses kind of what we call bandit signs out. Those are the types of people that buy houses that need a lot of work. That’s the first way you can sell it.
2. Sell With a Resident
A lot of times, you can get a little bit more money for this, but a lot of times, the people that are buying it want a renovated rehabbed house.If you’ve had a resident living there for a long time, this is probably not the right thing for you to do if it needs a lot of work. You can definitely sell it with a resident in it, and you can actually get a little bit more money based on someone having income coming in immediately.
3. Renovate
Once the resident moves out, you spend some money and renovate it and sell it on the retail market to an end-user. This is kind of obviously the area needs to work for this, but this is kind of a top dollar way to sell your rental house.Sell it to an end-user, sell it to someone that’s going to live there, sell it to somebody that gets a mortgage, or may even pay cash for it. But that’s it.
Capital Gains Tax
Of the taxes you will pay when selling your rental property, the most significant you will need to pay attention to is your capital gains tax. When you sell your rental property at a profit, capital gains tax is the charge you will pay as a result. Exactly how much you will pay in capital gains tax is dependent on three main factors:
- Income bracket
- Years of ownership of property
- Reducing tax methods
Calculating Capital Gains Tax
Capital gains tax takes two primary forms as either short-term or long-term capital gains.
Short-Term Capital Gains Tax
If you have owned your rental property for less than a year before selling, you are liable for short-term capital gains tax. Short-term capital gains tax for rental properties comes at the same rate as income tax, which is dependent on your income tax bracket.
Long-Term Capital Gains Tax
Long-term capital gains tax comes into play if you have owned your rental property for more than one year when you are selling. These taxes are also dependent on your income.There are three rates for long-term capital gains tax, 0%, 15%, or 20%. The 2021 long-term capital gains tax brackets are as follows:
- 0%
- Single: up to $40,400
- Married filing jointly: up to $80,800
- Married filing separately: up to $40,400
- Head of household: up to $54,100
- 15%
- Single: $40,401 to $445,850
- Married filing jointly: $80,801 to $501,600
- Married filing separately: $40,401 to $250,800
- Head of household: $54,101 to $473,750
- 20%
- Single: over $445,850
- Married filing jointly: over $501,600
- Married filing separately: over $250,800
- Head of household: over $473,750
Suggested Reading: How can I sell my house fast without losing money?
How to Avoid Capital Gains Tax on Rental Property
Capital gains taxes can cost you up to 20%. Considering how significant they can be, it’s no wonder why real estate investors constantly search for ways to avoid steep charges. Thankfully, there are a few different methods to help you avoid or lower your capital gains taxes when it comes time to sell your rental property.
Section 1031 Real Estate Exchange
Real estate investors looking to expand their portfolio might want to consider a section 1031 real estate exchange. A 1031 exchange is an excellent opportunity to avoid paying capital gains taxes on the sale of your rental property.Under section 1031, you take the profit from the sale of your rental property and move it into another similar investment opportunity. You can find out more information, including the qualifying criteria for a 1031 real estate exchange, through the IRS website.
Offsetting Property Gains
Offsetting property gains for losses is also known as tax-loss harvesting. If you experience any capital losses within the same tax year of your rental sale, you might want this option. This technique is commonly used by those who invest in stocks and shares and works well in real estate.Check out more information about capital gains and losses from the IRS website’s 10 Helpful Facts to Know.
Converting Rental Property
Another common technique used to help lower tax on the sale of rental property is by converting it into a primary residence. Homeowners selling their homes have fewer tax liabilities than those selling a rental property for profit.According to IRS Section 121, you can exclude up to $250,000 or $500,000 for the last five years for single or married individuals, respectively.
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Selling a rental property comes with several considerations. Not only do you need to mind the condition of the sale but you'll also need to pay attention to the associated taxes. While capital gains taxes can be significant, luckily, there are options available to help reduce some of these costs.I hope these tips will save you some future headaches when selling your rental property. If you have any questions about these tips, feel free to reach out and speak with a member of our team.
