A simple guide to selling rental property without paying taxes

There comes a point in nearly every real estate investor's journey where they need to sell a rental property. 

You might want the cash, a new property (which can help you avoid any capital gains tax paid to the IRS when done through a 1031 exchange), or to get out of the landlord business altogether.

Before we dive into the options you have to sell a rental property, let’s first touch on how you can avoid paying a major tax bill on the profits made from your sale.

Key takeaways

• A 1031 exchange is one common way that investors defer paying taxes when they sell a rental property. 
• Options for selling a rental property include waiting for the tenant's lease to expire, paying the tenant to vacate, selling to your tenant, selling your property with an active lease, or listing on Roofstock's marketplace.
• Roofstock's marketplace allows sellers to market their properties to an international network of buyers who are often looking for tenant-occupied properties.

Tax advantageous ways to sell a property

Something that’s important to highlight is that there are a few tax advantageous ways to sell property. 

One is through a 1031 exchange which helps delay the payment of capital gains tax, both short-term and long-term capital gains. When an investment property is sold, you may have some hefty capital gains taxes depending on the amount of profit you realize from the sale. These taxes will be most notable at the federal level. The amount will vary based on your income according to the IRS, but in most cases it can be in the ballpark of 15%-20% for federal taxes on capital gains.

Depending on where you live, profit could also be taxed as income or gains at the state level. Additionally, accumulated depreciation recapture (i.e., the tax deductions you received by depreciating your asset over the time that you owned it) will need to be resolved and is taxed at a federal rate of 25% according to Investopedia, with varying rates at the state level. Definitely reach out to your CPA for a better understanding of your personal tax implications based on your situation. 

However, you may not owe any taxes at the time of sale if you execute your 1031 deferred exchange properly.

Also known as a “like-kind” exchange as described in Investopedia, a 1031 deferred exchange allows users to defer capital gains taxes if proceeds are reinvested in a new property or portfolio of properties of equal or higher value and loan amounts are either similar or higher. There are several other things that need to be considered, but these two are the big ones.

Something important to note in regards to hold times - as long as you hold your properties long enough and don’t trigger “dealer status” with the IRS (typically a two-year hold or longer), there are generally no limits on how many times or how frequently you can perform a 1031 deferred exchange.

Theoretically, 1031s can be done over and over again, selling properties and then reinvesting in like-kind properties, deferring taxes and building greater equity and value over time in perpetuity. 

Another great potential tax advantage is through selling your primary residence. Now this is an article about investment properties, so why mention a primary residence? This is a potential tax exemption for anyone that purchases a primary residence and then later converted it to a rental property.  

According to IRS.gov, “If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse.”

This comes with several caveats and you should consult with your tax professional about whether or not you may qualify. The biggest hurdle to overcome is the stipulation that you need to have lived in the property for 2 out of the last 5 years (it doesn’t have to be all at once though).

So, if you purchased a primary home, lived in it for 2 years, then moved out and turned it into a rental and have owned it for another 3 years or less as a rental, now may be an opportune time to sell from a tax savings standpoint. 

Selling traditional rental property 

Alternatively, selling an unoccupied home is relatively cut and dried: stage it, landscape it, list it, and wait for the offers.

With a tenant-occupied property, the process is a little more complicated. To begin, you’ll want to take a look at the type of lease you have in place.

If your renters are living under a month-to-month lease, a basic procedure would be:

1. Give your tenants written notice.
2. Remind them to remove their belongings by the last day. 
3. If they don’t move out at the scheduled date, start the eviction process. 

Some landlords install an early termination clause in the lease. These clauses stipulate that the lease can be broken under certain circumstances, like (a) lease terms not honored, (b) major neglect of property, or (c) landlord’s need/desire to sell.

When your tenants have a fixed-term lease without an early termination clause, tenants have more rights and landlords have less flexibility. If you absolutely must sell your occupied rental property, here’s a guide to your options.

(Of course, don’t forget to check your state’s landlord-tenant laws to make sure you’re doing everything by the book. Each state has different regulations on notice required for property showings and move out dates.)

1. Wait for lease expiration

As long as your tenants are paying rent and following the lease rules, they have a right to stay through the lease term; that is, unless the lease has an early termination clause (refer to above). Your first option would be to wait for the lease to run its course, at which point you can inform your tenants of your desire to sell and give them adequate notice. 

Pros: You’re honoring the lease you signed, earning rent while you wait, and making a clean break with fewer hard feelings, most likely.

Cons: You have to wait to sell. If it’s a seller’s market with 9 months left on the lease, that could be lost capital.

2. Pay your tenant to vacate

Tenants on a fixed-term lease might be open to negotiation: a settlement in which you pay them to move. This can ease the pain and expense of moving while creating an incentive for the tenant to vacate. Before you choose this option, come up with a calculated figure based on:

1. Moving costs: Offer to reimburse your tenants for their moving expenses.
2. Rent difference: If a comparable home nearby has slightly higher rent, offer to pay the difference for the months left on your lease.
3. Cover security deposit: Moving into a new place, your tenant will need to pay the first month’s rent with a security deposit. You could offer to pay their security deposit for the new place.
4. A ballpark number: If a quick sale of your home promises a huge return, you might be willing to pay your tenants a sweeter sum to encourage them to move.

Pros: Money talks, as the saying goes, and a cash offer could encourage a faster move and ease any tensions.

Cons: Depending on the circumstances — e.g., time left on lease, local rent prices, moving costs — you might be shelling out a big chunk of change to get tenants to move.

3. Sell to your tenant

Say you have a good tenant who not only loves your home but is eventually looking to buy. In this case, why not offer them the property? It’s a goodwill gesture — in that you’re coming to the table with an offer for them to stay rather than leave — and would lead to a relatively quick and painless sale. 

If your tenant is unable to get traditional financing, you can always offer seller financing, in which you receive regular payments from the buyer that take into account interest, payment schedule, and default situations. Seller financing usually occurs over a short period of time until the tenant can secure a mortgage.

Pros: You’d be selling to a person who already knows and loves the house…and no one has to move.

Cons: If your tenant needs seller financing, you’ll need to already own the home outright, and the buyer can default on the loan. Also, your tenant — shifting into buyer’s mode — might request changes or extraneous repairs to the home as part of sale. 

4. Sell 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. 

Pros: You’re quickly cashing out of your investment and handing over the reins to a new landlord. It’s a relatively smooth transaction for the buyer, seller, and tenants.

Cons: This is not the type of sale you can just list on the MLS. Your buyer pool is limited to investors or those patient enough to let a lease expire until they either move in, renovate, or write a new lease. These buyers can be difficult to weed out.

5. List through Roofstock

Overall, it’s no easy task selling a rental home with tenants in place. You essentially need to find someone who’s willing to take over your investment project without changing too much. A truly seamless route would be to list your home in a marketplace tailored for investors who actually want tenants in place. 

This is how Roofstock works...

Roofstock is the leading marketplace for selling rental properties. Landlords around the world choose us to list their rentals because it’s simple, effective, and primarily online. You don’t have to put signs in the yard or schedule showings.

When you list your rental home on Roofstock, you’re connecting directly to a global network of buyers who want what you’re offering — a turnkey rental real estate property.

Here are a few benefits of using Roofstock to sell your rental:

• Market your property to an international network of real estate investors
• Retain your tenants and rental income cash flow through closing
• Publish an attractive online listing built on the key metrics and property information Roofstock gathers for you
• Transact online — you don’t even have to leave the house
• Enjoy a hands-off process during which Roofstock communicates on your behalf with potential buyers and optional property managers
• Get a low 3.0% transaction fee (or $2,500, whichever is greater)

What’s the process?

Listing and selling your home through Roofstock couldn’t be easier. Here are the basic steps:

1. Submit your listing: Enter your property’s information in our system and we’ll generate a complimentary valuation report.
2. Set the purchase price: Using this valuation report, we’ll work with you to set a fair price that both attracts investors and meets your financial goals.
3. Let us take the lead: Roofstock gathers current lease information and other important documents which will be used to create your listing. We also provide key financial metrics and market area information to emphasize investment potential.
4. Receive offers and close: Offers come to you directly online. Once you accept an offer, Roofstock oversees the entire closing process through to closing. 
5. Collect rent until closing: If the property has tenants, your rent cash flow doesn’t stop until the deal is done.

Roofstock helps remove the guesswork and headaches from your rental home sale. Compared to the other options for selling with tenants, it presents fewer hurdles for the seller, buyer, and the people living in your property.

Removing your tenants and selling a rental home the standard way using an agent, broker, and title company could lead to longer waiting periods, lost rent, steep brokerage fees, and other expenses related to interior staging and outdoor landscaping. 

The Roofstock method allows you to keep your tenants in place, keep the rent flowing through the entire process, and the fees are minimal. Plus, Roofstock helps makes the entire process easier by handling a lot of the finer details and requiring sellers to have fewer points of contact.

To view more information on how this works, visit our selling platform, where you can find additional data, explainer videos, and easy account set-up.