When is the best time to sell your rental properties?

Q: I am 60 years old with a pension. I have invested in rental properties in the past. I currently own six rental properties. I have no mortgages on these properties and paid around $100,000 for each of them some years ago. They are now worth around $350,000 each.

I’m wondering whether I should sell them, take out mortgages on them or do nothing. If I sell them, I’m not going to buy another rental property with the money. But prices are at an all-time high. Then if I sell them and leave the money in cash or in the bank, inflation will eat away at my money. I’m really at a loss on what to do.

A: You sound as though you’re in good shape financially. You describe yourself as having a pension, and we imagine you’re also getting some Social Security each month. But, do you need cash for a specific reason? Do you need to pay bills or are you looking for an easier way to generate extra income rather than managing six real estate properties?

Let’s look at the numbers. You invested $600,000 in real estate that is now worth $2,100,000. If you sell these properties now, there will be a hefty tax bill to pay to the IRS and perhaps your state taxing authority.

It seems as though your profit would be around $1,500,000, minus any costs of sale and any capital improvements you made to the properties over the years. That could reduce your profit. But assuming the $1.5 million is a net profit number, you’d owe the federal government 23.8% of $1.5 million. That comes to $357,000.

But we’re not done yet. The IRS will want to recover any depreciation you took on the properties through the years. So, if you took $200,000 in depreciation since you purchased the properties, you’ll owe another $50,000 to recapture the depreciation. So, your total tax hit to the IRS could be around $407,000. You’d still pocket around $1.1 million in profit including the $600,000 you put in originally, however. A nice return on your initial investment.

Before you sell, talk through the specific numbers with your tax accountant so you know what you’re facing.

As for it being a good time to sell, it might be. But it’s always hard to time the market, and selling investment properties depends quite a bit on what rent your properties are generating. Since you don’t have any mortgages, we assume the rent money you receive on your rentals exceeds your expenses. If you’re generating a return of 10% on your $2,100,000 worth of property value, that comes to $210,000 in income after expenses. Once you cash out, will you want to invest for cash or for growth? Leaving the money in the bank will eat away at inflation, but a financial advisor can help you structure a portfolio that will make sense for you.

Finally, you should know that under current law, when you die the person that inherits your buildings will inherit them at the value they had at the time of your death. This means that if you die and your estate is below the amount that triggers an estate tax — currently set at $13.61 million dollars for an individual and $27.22 million for a married couple, although this is scheduled to revert at the end of 2025 — you won’t pay any taxes on these properties at the time of your death. Your heir also won’t pay any taxes if they sell them within a year of your death.

Of course, we’re making a bunch of assumptions that could impact how you move forward. We don’t know how much time you spend on caring and managing your rental properties. It might be too much, now that you’re 60. So that will factor into your decision. But the one thing we know for sure is if you sell, you’ll have a big tax bill to pay.

You can figure this out by asking yourself these two questions: Do I need cash now? And, am I sick of managing these six rental properties? If the answer to both questions is yes, then explore a sale. If the answer to both is no, then continue on your current path. If the answer to one is yes and the other is no, then you’ll need to dig deeper to figure out your next steps. Your accountant and real estate attorney can provide more specific guidance.

========

(Ilyce Glink is the author of “100 Questions Every First-Time Home Buyer Should Ask” (4th Edition). She is also the CEO of Best Money Moves, a financial wellness technology company. Samuel J. Tamkin is a Chicago-based real estate attorney. Contact Ilyce and Sam through her website, ThinkGlink.com.)