Here’s a common scenario in the landlord world – while a lease agreement is in place, either the landlord wants to sell his residential rental property, or the tenant is interested in purchasing it.
If the tenant wants to buy the home he’s renting, and the landlord is open to the idea, then a transaction can likely move along swiftly and easily.
Most of the time, though, either the landlord wants (or needs) to sell the home, and the tenant wants to keep renting, or the tenant is ready to buy and if he cannot purchase the house he’s living in, he intends to move out as quickly as possible.
Let’s walk through the essential factors to keep in mind when considering selling your rental home to a tenant or a non-tenant buyer.
Tax Considerations. If you plan on buying another rental property with the proceeds of the sale of an existing rental property, then become fully versed in the IRS 1031 exchange provisions. Doing a 1031 exchange enables you to defer the taxes on your capital gains (either short or long-term) by reinvesting them into a new rental property.
While the amount of Federal taxation on your capital gains varies by your income, in most cases any capital gains realized through the sale of rental property are subject to a 15% to 20% Federal tax. State capital gains taxes may also apply. Accumulated depreciation recapture will need to be resolved (the tax deductions you received by depreciating the property over the time you owned it). That could also add to your tax bill.
I’m presenting this discussion to you in this article to give you the questions you need to ask your accountant or tax professional. Don’t make assumptions about potential tax liability. Get definitive answers to all tax questions before you enter into any real estate transaction.
You Want To Sell, But Your Tenant Wants To Stay. Maybe you have an opportunity to buy another rental property and need to cash out of an existing asset to make that happen. Perhaps the real estate market is hot, and you think it’s time to sell. Whatever your motivations are, you have tenants. They have a lease that extends several months more, and they don’t want to move.
Of course, you cannot break the lease and force your tenants to leave. If you do not have an early termination clause in your lease agreement that gives you the right to sell your property during the lease term, you’re stuck unless you can get your tenant to cooperate.
Here are three ideas to consider to resolve this conflict:
Pay Your Tenant To Vacate. Before you offer your tenant a deal, do your homework. How much money are you expecting to net when you sell the property? For example, if you’re in a red hot real estate market and you’re concerned that delaying a sale for even a few months might cost you tens of thousands of dollars, it might be worth it to you to offer the tenant some financial incentives.
You can offer to pay the tenants’ moving costs, which can be substantial. Another potential incentive – reduce the tenant’s rent (or eliminate it) for the amount of time required to sell your property, say 90 to 120 days. Your tenant will likely have to pay a security deposit on a new rental, so you can offer to pay that expense.
Get creative! Whatever you agree to will need to put in the form of an addendum to your lease agreement and signed by both parties, but you have wide latitude in coming up with a deal that works for both sides.
If you do not have a sale locked up (you’re going to market the property), then be sure to set clear rules about the ability to show the property to potential buyers and the general cleanliness of the property during this sales period. Tie all tenant requirements to tenant incentives.
Consider Selling your Property With An Active Lease. Another option is to find a buyer who’ll purchase your tenant-occupied investment property with a current lease in place. The new owner would allow the tenants to live in the home through the lease period, after which it would be up to the new owner to keep the tenants under a new lease or make other plans.
A wrinkle here – this is not the type of sale that most realtors can easily handle through MLS. It can be a challenge to weed out the buyers who want to own the property and accept the existing tenants.
Offer The Tenant Seller Financing. Let’s say that you need to net $25,000 out of the deal to invest in another rental property you’ve got your eye on. Plus, if you’re going to buy another rental property, you don’t want the financial burden of maintenance and upkeep on your existing rental.
You could offer to carry the tenant’s financing at a reasonable interest rate for 24 to 36 months (or even longer). That would give the tenant some flexibility, allowing them time to get their finances together and enter into a conventional mortgage. It also puts some cash in your pocket (the $25,000 down payment) and relieves you of all obligations to maintain the property. Plus, your stake in the property (the balance of the purchase price) will likely earn a well above average interest rate over the 24 to 36 months term, further increasing your overall return on investment.
Do you have questions about property management? Let’s discuss what’s on your mind and get you the answers you require. Please give me a ring at 914-355-3277 or send me an email at Linda@sterlingpsi.com.