Why Selling Your Rental Property Might Not Be Your Best Move

When it comes to real estate investments, the decision to sell a property is one that comes with a myriad of considerations. While the allure of liquidating an asset for immediate cash can be tempting, there are several reasons why holding onto your rental property might be the more advantageous choice. Let’s delve into the financial implications of selling, and why keeping that property might be the smarter move for your long-term wealth.

1. Tax Implications

One of the most significant deterrents to selling a rental property is the tax implications. When you sell a rental property, you’re subject to:

• Capital Gains Tax: If your property has appreciated in value since you purchased it (which is often the case), you’ll be liable for capital gains tax on the profit. Depending on how long you’ve owned the property, this could be taxed at a short-term or long-term rate. For many, the long-term capital gains tax rate ranges from 0% to 20%, but it can be even higher when you factor in state taxes.
• Depreciation Recapture: One of the benefits of owning a rental property is the ability to write off the depreciation of the property on your taxes. However, when you sell, the IRS wants a piece of that benefit back. This is known as depreciation recapture, which is taxed at a maximum rate of 25%.

2. Realtor Fees

Selling a property isn’t free. Realtor commissions typically range from 5% to 6% of the property’s sale price. On a $300,000 property, that’s $15,000 to $18,000 right off the top.

3. Equity and Balance Sheets

While it’s true that selling your property can provide a lump sum of cash, it’s essential to remember that the equity you’ve built in your property is already an asset on your balance sheet. Liquidating this asset doesn’t necessarily mean you’re “making” money—it just shifts its form.

4. Inflation and Asset Appreciation

Inflation erodes the purchasing power of cash over time. If you don’t have a solid investment plan for the proceeds from a property sale, you could find the real value of that money diminishing year after year. In contrast, real estate often appreciates over time, acting as a hedge against inflation.

5. Principal Pay Down and Appreciation

Even if your rental property isn’t generating significant cash flow due to loan payments or other expenses, it’s crucial to remember the other financial benefits:

• Principal Pay Down: Every mortgage payment includes a portion that goes towards the principal. Over time, this reduces your loan amount and builds equity.
• Appreciation: Historically, real estate tends to appreciate. Even if you’re breaking even on cash flow, the property’s value might be steadily increasing.
• Tax Benefits: Beyond depreciation, property owners can often deduct mortgage interest, property taxes, property management fees and other expenses, further reducing their taxable income.

An Alternative: Refinancing

When considering whether to refinance or sell your property, it’s essential to weigh the associated costs of each option. Let’s break down the costs for a clearer comparison:

Property Details:

• Current Value: $300,000
• Outstanding Loan: $150,000

Refinancing:

• Refinancing up to 80% of the property’s value ($240,000) allows you to pull out $90,000 in cash.
• Refinancing Costs: Typically 3.5% of the loan’s principal, which amounts to $8,400.

Selling:

• Realtor Commissions: Approximately 6% of the property’s sale price, or $18,000.
• Closing Costs: Typically 2% of the sale price, or $6,000.
• Capital Gains Tax: Assuming a $50,000 appreciation and a 15% tax bracket, that’s $7,500.

Comparison:

• Refinancing costs you $8,400.
• Selling costs you a total of $31,500 (Realtor fees + closing costs + capital gains tax).

In this comparison, selling incurs nearly four times the costs of refinancing. Moreover, selling means parting with an appreciating asset and potential future rental income, while refinancing allows you to retain the property and its associated benefits. Now may not be the time to refinance with the current interest rate levels, but each situation is different and should be evaluated by a tax professional.

Conclusion

While selling a rental property might seem like a quick way to access cash, the long-term financial implications often make holding onto the property a wiser choice. Before making any decisions, always consult with financial and tax professionals to understand the full scope of your situation.

About the Author

Malory Medaglia is the Property Management Advisor at Beaufort Rentals. With an innate understanding of the local market intricacies, Malory’s expertise has been invaluable in guiding homeowners through the maze of property management. Her dedication to excellence ensures that our clients receive unparalleled advice and service.

If you’re contemplating stepping into the world of property rentals or seeking guidance about our services, Malory is your ultimate go-to professional. You can reach out to her via email at malory@beaufort.rent or give her a call at (843) 441-7320.