Let me share when is the best time to sell rental property with a logical framework. As a rental property owner since 2003, I’ve often considered selling a rental property to be more free.
“Should I Sell My Rental Property And Simplify Life?” was written in frustration due to unnecessary conflict between my tenants and their downstairs neighbor. I’ve had some time to think more objectively about the incident. I also talked to a couple older landlords to come to a more rational decision.
When I had no online income, real estate income was by far my favorite income stream. Now that my online income has grown, I’m becoming obsessed with the idea of being as unencumbered as possible to make money. I’ve compared rental income with online income, and online income has more upside.
Early retirees become totally spoiled with our time because we never have answer to anybody. So when we have to do something that’s unpleasant, such as play peace keeper, we get very bummed out. (Read: “What Does Early Retirement Feel Like? The Positives And Negatives“)
As you know from previous articles, I spend an exorbitant amount of time doing research on anything that has large financial consequences. I calculate various scenarios, talk to friends and family, and speak to as many industry veterans as I can find.
After consulting with several 55+ year old rental property owners who’ve owned their properties for over 25 years and comparing notes, I’ve come up with three tangible targets to determine the best time to sell rental property.
Math not emotion is what’s going to help make the best financial choices!
The Best Times To Sell Rental Property
Best Times To Sell Rental Property
The base case assumption is that we should own our property forever. Rents will continue to rise due to population growth and inflation, while land is finite. Every time I think about selling a piece of property to simplify life, I think about how I’ll be kicking myself 10, 15, 20, 25 years from now for selling so cheap. Just think back to where rents or property prices were just 10 years ago and I’m sure you’d agree.
Real estate almost always seems expensive at the time of purchase because real estate is almost always the largest asset you’ll buy in your life time. Unless you’re really disciplined by buying below your means, you’ll generally tend to buy what you can afford or stretch to the max instead.
As we get older and hopefully wealthier, time becomes more of a premium over money. Rental property is the most active of my passive income streams, but the ideal scenario is to earn lots of money and seriously do nothing at all. The problem with totally inactive money is that CD returns are too low while stocks and bonds can turn violent in any given year.
If we can’t hold onto the property forever by at least hiring a property manager for one month’s rent as pay, then we should consider holding on until one or all of the following three targets are met. Here are the three best times to sell rental property.
1) When your depreciation benefit runs out.
Depreciation is a non-cash expense which every rental property owner can take. You can usually either accelerate your depreciation or straight-line depreciation. The most common form of depreciation is the straight-line depreciation method which is taken of an IRS instituted 27.5 years.
1. Purchase price – Land Value = Building Value.
2. Building Value / 27.5 = Annual allowable depreciation deduction.
1. $500,000 purchase price – $200,000 land value = $300,000 building value
2. $300,000 building value / 27.5 = $10,909 annual allowable depreciation deduction.
3. Current annual rental income is $20,000 (4% gross rental yield).
4. Taxable rental income if we include no other costs like property tax, maintenance, and HOA costs for simplicity purposes = $20,000 – 10,909 = $9,091.
5. Total tax savings if you are in the 25% federal tax bracket = $10,909 X 0.25 = $2,727.
Depreciation Doesn’t Last forever
Deprecation expense is all about saving on taxes. You may be able to select accelerated depreciation instead, which basically front loads the depreciation costs to get a bigger deduction. Best to check with your accountant and state laws. Here is the IRS page on depreciation which doesn’t do a very good job explaining because it is so damn long and confusing!
The depreciation criteria basically states that you should aim to hold on to your property for the amount of years you are allowed to depreciate. While I was in the 36% federal tax bracket (39.6% current equivalent), I maximized depreciation and all my rental expenses. As a result, I was making a net loss on my main rental property. Now that I’ve started a company and make less reported income, I’m much more willing to earn income from my rental given my lower tax bracket.
It’s important to note that depreciation amounts get adjusted back during time of sale (aka depreciation recapture). For example, if you took 20 years of depreciation at $10,909 a year, you would reduce your cost basis of the $500,000 purchase price by $218,180 (10 X $10,909) = $281,820.
With a lower cost basis, you would pay more taxes due to a higher difference in sales price vs. adjusted cost basis. Depreciation isn’t free money in the end. This is why you need to be proactive in your estate and tax planning.
One final point. Once you exceed $150k AGI (married filing jointly) you lose all rental losses as rental is considered a passive activity. You still accumulate the Net Operating Losses until you dispose of the property, or when your income is below that threshold. But you will not get any tax benefit on an annual basis. Hence, when it’s time to sell, make sure you make less than $150,000!
3) When you can tap your 401(k) or IRA at age 59.5.
Hopefully everyone will have amassed a healthy chunk of wealth in their 401(k) or IRAs by age 59.5. Please see “How Much Should I Have In My 401(k) By Age” and “How Much Should I Have Saved In My IRA By Age” for some progress guidelines. The idea is to receive the income and taxation benefits of a rental property until the age where you can withdraw from your 401(k) or IRA penalty free.
As of now, there is a 10% early withdrawal fee on your 401(k) or IRA. The idea is to let your money compound over time. Prevent the temptation to spend your money now.
A perfect time to buy rental property is therefore around the age of 32 due to the 27.5 years of straight-line depreciation. By the time you are 59.5, you can probably sell your rental property for a handsome profit. You can also start taking penalty free withdrawals from your 401(k) and IRA and live a carefree life!
3) When you can begin collecting Social Security and Medicare.
You’re welcome to delay the sale of your rental property if you can hold out long enough for Social Security. The earliest you can currently start accepting Social Security is age 62. I’d be more conservative and expect the earliest age to accept to increase to 65 by the time you retire.
Receiving rental property income while receiving distributions from your 401(k) and IRA for the next two to five years isn’t a bad idea after age 59.5. By 65, I’m sure most of us will really want to simplify life. If I’m thinking of simplifying life after 10 years of rental property ownership at age 36, I know I’ll be longing for a simpler life 30 years from now!
Own Your Rental Property For As Long As Possible
Rental property should be a core part of anybody’s passive income stream portfolio. I’m a big believer in having an equal distribution of rental property, stocks, and bonds/CDs/risk-free assets making up one’s net worth.
Read “Net Worth Allocation Recommendation By Age And Work Experience.” You’ve essentially got two parts offense that makes up 60-70% of your net worth, and one part defense (CDs) which can turn to offense when buying opportunities arise.
There will come a point in every rental property owner’s life where they just don’t want to deal with even a innocuous e-mail inquiry from a tenant anymore. Although I’m only in my mid-30s, I’m living more like a typical empty nest 65 year old retiree.
The other mathematically right time to sell is when the property’s cap rate is sustainably lower than the risk-free rate. But these figures are constantly moving and it’s not easy time.
I’m still considering selling one rental property before I relocate to Hawaii. However, now that there are exact ownership targets (the number of depreciation years left, age 59.5, and age 62), I’m going to do my best to own for at least 17.5 more years until my depreciation runs out. Building passive income really is like a game and I love this newfound challenge!
Take Advantage Of Lower Mortgage Rates Today
Credible offers some of the lowest refinance rates today because they have a huge network of lenders to pull from. If you’re looking to buy a new home or refinance, Credible is a great solution. Interest rates are back down near ALL-TIME lows. Take advantage. When banks compete, you win.
Invest In Real Estate More Surgically
In addition to own rental properties, invest in real estate crowdfunding across the country. There is a demographic trend towards lower-cost areas of the country. Take a look at Fundrise, one of the largest real estate crowdsourcing companies today.
Real estate is a key component of a diversified portfolio. Real estate crowdsourcing allows you to be more flexible in your real estate investments by investing beyond just where you live for the best returns possible.
For example, cap rates are around 3% in San Francisco. But they are over 10% in the Midwest and south. As a result, I invested $810,000 in real estate crowdfunding to diversify and earn income 100% passively.
I also really like CrowdStreet, a real estate platform that focuses primarily on individual deals in 18-hour cities. 18-hour cities have lower valuations, higher cap rates, and higher growth rates. As more people relocate to lower-cost areas of the country, 18-hour city real estate should benefit.
Both platforms are free to sign up and explore. I’ve personally invested $810,000 in real estate crowdfunding so far.