How To Sell Your Rental Property
You’ve spent a long time building equity in your property and maximizing its appreciation. When you’re satisfied with your investment, or are ready to move on to your next one, it’s time to sell.
However, you can’t sell without first understanding the legal and logistical steps of a property sale. This is because without adequate selling preparation, you could end up missing out on a great deal or frustrating your tenants into leaving.
This is bad news for both you and your future buyer. Tenant cooperation helps you achieve a higher sales price and guarantees immediate cash flow for your buyer. When the sale proceeds smoothly and speedily, everyone benefits.
You can facilitate a straightforward sale in each step of the process. Each sale is different, but in general you must complete the same basic legal steps: clearing liens, transferring the property title, migrating leases to the new owner, and paying tax on the sale.
In this article, we review and explain each of the legal steps to selling your rental property.
Transferring the Property Title
Once you’ve found a buyer, you must complete the legal process of transferring property ownership. There are two steps when transferring a house title: verifying that liens on the property are cleared and transferring the property deed. These steps are done to ensure that a title search on the property returns clean and that the property has what's known as "clear title." Then, local deed records will need to be updated with the county recorder so that future a deed search appears correctly and the new ownership of the land and property can be officially recorded.
Conducting a Property Lien Search
Start by finding out whether there are any liens on your property. A mortgage lien is the legal claim against a property by your creditor, which they retain until you pay off your mortgage debt. The lien prevents you from selling the property and transferring ownership rights while you owe money.
A smart buyer will conduct a property lien search (at the escrow office or online) to discover whether there are any liens on your property. This helps identify and resolve any legal obstacles to transferring the property title from the previous property owner to the new one. This is also the purpose of title insurance and title insurance policies, which protect you should you later find out there is an issue with the property's title history.
Your job is to make sure your property has a “clear title,” which means there are no active liens on it. Title searches will reveal active liens and other title issues. You have two options to achieve a clear title: You can either pay off your mortgage debt or negotiate with your creditor.
If your mortgage is paid off, you will begin a conventional sale, a real estate transaction in which the seller owns the property outright or owes less on their mortgage than what the market indicates they could sell their property for. This kind of sale is typically the smoothest form of real estate transaction.
A lien release legal document finalizes this process and serves as proof that the lien has been removed and the creditor no longer has a claim on the property. A warranty deed is a legal real estate document where the seller guarantees that they have a clear title to the property and have the legal rights to sell it to the buyer. An experienced attorney can help you navigate each of these steps with the title company and obtain a lien release or warranty deed.
Transferring the Property Title
After clearing all liens, you can legally sell your property. This means formally transferring the property title and legal ownership to the new buyer.
Here’s how:
- First, locate the appropriate deed for the sale. A general warranty deed, the most common type of real estate deed, transfers the property and all its interests from seller to buyer.
- Next, hire an accredited real estate attorney to prepare the deed. While it’s possible to prepare a deed without one, you are more likely to make mistakes on your own.
- Review the deed and ensure that the buyer’s information is correct.
- Take the deed to a public notary and sign it in front of them.
- Finally, file the signed deed with the local county records office. You’ll have to pay certain fees and taxes to record the deed. Real estate transfer tax is a charge on the transfer of ownership or title to property from one individual or entity to another. Transfer taxes are a one-time tax or fee imposed by a state or local government upon the transfer of real property.
Transferring Existing Leases
If the buyer you’ve chosen is an investor, you are responsible for the additional step of transferring leases.
Have these documents ready:
- Existing, signed rental agreements
- The location of security deposits (bank accounts) and interest rates
- Property tax bills and seller tax returns
- Any insurance claims
- A full maintenance history of the property
- Information about utility bills you pay
- HOA documents
- Relevant financial statements
Your buyer will review the existing leases as well as these other documents. Then, you’ll need to transfer the property details, security deposits, and other essential information during the property title transfer.
Be sure to notify your tenants in writing at least 10 days before the transfer, or as per real estate law in your state or as established by local governments. Provide them with the new owner’s name and their contact information. You should also explain where the security deposit has moved and clarify how to pay rent in the future.
Your tenants may wish to negotiate with their new landlord for rate decreases, lease modifications, or other changes.
Taxes: Calculating Depreciation and Recapture
We’ve reached the final (and most dreaded) step in the sales process: taxes.
Rental property taxes can be complex. Here, we break down the basic concepts of sold rental property depreciation and recapture to help you understand how the sale of your property will be taxed.
What is Depreciation?
Buildings and other kinds of property are assumed to slowly lose value over time due to wear and tear. This process is called depreciation.
Because your property depreciated over time, you were able to take depreciation deductions each tax season. Essentially, you subtracted a portion of the property’s cost basis (value) from the income you reported to the IRS, so you wouldn’t have to pay tax on it.
What is Recapture?
Remember what we said before about properties losing value over time? This is true, but it isn’t the whole story. In fact, most properties—depending on the property description and if improved and maintained by a good owner—actually appreciate over time.
Because depreciation still lowered your taxes, the IRS wants to reclaim some of the tax you’re avoiding. This is called recapture, and it’s taxed at 25%. Regular capital gains rates for the rest of your sale fall between 0-20%.
Here’s the bottom line: You avoided paying taxes throughout your landlord career by taking depreciation deductions. When you sell, the IRS taxes your profits because of those deductions.
Tax Tips for Selling Your Rental Property
Here are some tax tips and tricks for selling your property:
- Make a 1031 (Like-Kind) exchange to defer capital gains taxes. If you exchange your property for a similar real property in the U.S. instead of selling, you can avoid paying tax. However, 1031 exchanges are complex. You may need the help of a Qualified Intermediary (QI) to facilitate the exchange.
- Live in your property for two years before selling it. According to the Home Sale Exclusion, you can get tax breaks if the property is your principal home when you sell it. A “principal home” must be your primary residence for two out of the last five years leading up to the sale.
Conclusion
Selling a property is an arduous process involving many administrative, legal, and tax steps. A thorough understanding of each step is critical to a smooth transfer of ownership to your buyer. By completing all the steps included in this article, you can sell your property as quickly and efficiently as possible.
