Four Common Reasons Landlords May Sell Rental Property

  • Four Reasons Landlords Sell Rental Property - Real Property 1031 exchangeSelling because the market has plateaued: From 1994 to 2019 home values rose at an average of 3.9% per year. However, in 2019, home values slipped to 3.8% per year.3 In 2020, twenty five (25) is the average number of days a home is on the market. 4 Replacement properties are scarce and 1031 exchange timelines are strained.
  • Selling while taxes are low: According to an article from CNBC, billionaires Warren Buffett and Bill Gates suggested increasing taxes on the wealthy to pay for policies that would help people without market skills keep pace in an increasingly specialized economy.5 As a reminder, the 1986 Tax Reform Act 1) eliminated the capital gains tax differential; 2) created passive loss limitation rules; and 3) lengthened the tax write-off period for real property. What ensued was a sell-off of commercial real estate by many. The sell-off depressed property values which led to loan restructures which, some argue, led to the creation of the Resolution Trust Corporation. This is a basic explanation of the savings and loan crisis which really began in the late seventies. The point is that tax law changes matter and those who can sell prior to a decline in real estate prices and position their replacement property potentially tend to fair better than those who cannot or do not take action.
  • Selling before the properties age: Single family rental properties are aging across the country. The rule of thumb is maintenance costs are approximately 1-4% of the home’s value. However, as the home ages the maintenance costs rise approximately 1% per decade. So, if a landlord owns a 30 year old property, it is also costing more (approximately 3%) to maintain, for example. If it is also “depreciated out,” the tax advantages don’t offset the rising maintenance costs. Each of these factors affect the Taxable Equivalent Yield – T.E.Y. – (i.e., Tax-adjusted Cap Rate) of rental property.
  • Selling before the landlords age: Individuals who jointly own rental property often disagree on the lifestyle they’d like to lead. One partner may want to travel or spend more time with the grandkids while the other feels the need to “double down” on the rental business. The joy of owning rental properties may lose its luster over time and many are increasingly aware of this. Once tax advantages are reduced (depreciated out) and maintenance costs have risen (aging property), individuals may be left soley focusing on a remaining goal of monthly income.

Can a Landlord Retire?

In our experience, many clients who work a 9 to 5 job tend to leave the rental business to the spouse or partner with the most flexible schedule. Over time, one partner may envision retirement as leaving a job and “retiring” into the rental business while the other may want to retire out of the rental business.

Older individuals, who once performed all the maintenance on their rental properties, may find it physically impossible to keep up the pace of their younger years. The costs of hiring and out-sourcing maintenance reduces their monthly income at the very time in their lives that they may need it most.

Lastly with respect to spouses, couples may disagree on “what the children want.” One past client told us that he was going to leave all of his rentals to his son. His wife, active in their business, responded that their son didn’t want or need the rent houses. Interestingly, the son, a cardiothoracic surgeon living in another state had not yet been consulted. Leaving an inheritance of rental units can be good for some heirs, but a giant headache for others.

These are common reasons we’ve seen landlords seeking an answer to “how to retire.” They are not, however, every reason. Each landlord is in a different place. Some simply need to “downsize” (from 5 renthouses to 2), while others want to sell everything and upscale into a Delaware Statutory Trust (DST), when suitable. The attractiveness of more income potential is leading many to join the growing number of real estate investors who are moving from active to passive real estate.

1031 Exchange Investment Option

Exit strategies are important for business owners, CEOs, investors and landlords. How to use tax laws and investment strategies to create income potential, save taxes and transfer wealth to the next generation is what we do professionally. DSTs are one tool, if suitable.

Delaware Statutory Trusts (DSTs) are growing in popularity as replacement property.6 The concept for business trusts dealing with property have been used since the 16th century, but it wasn’t until 1947 common law began to recognize statutory trusts in Delaware and 1947 legally recognized with additional federal recognition in 2004.

Addressing Landlords’ Concerns

Concern: The rise in property values and rent payments have slowed to a crawl.

Possible Solution: A DST helps provide diversification of property type and geographical location. Examples include multi-family residential, office, retail, industrial, hospitality, assisted living, golf courses, self-storage, and even oil and gas producing wells. DSTs seek to provide a projected rising income to help mitigate inflation.

Concern: Taxes – capital gains, ACA7 tax and depreciation recapture.

Possible Solution: A DST is eligible for 1031 exchanges which defers taxes in the year in which the rental property is sold. Sometimes two properties are exchanged with cash leftover. This is called “boot” and it creates an unwanted taxable event. A DST is a popular solution to the “boot” problem. Additionally, a DST is a popular estate planning tool because re-registration can be inexpensive and DST’s help streamline the passing of real estate to heirs, who, in turn, receive a step-up in cost basis. This step-up can eliminate the inherited capital gains tax on that property.

Concern: Cash calls, Recourse loans, etc.

With DSTs, there are no “cash calls” for maintenance, insurance or taxes. New properties create a new depreciation schedule. So, the tax advantages of depreciation are “passed through” to the beneficiary owner reducing the taxable amount of each monthly potential rental income check. Seven restrictions8 of the DST protect the beneficiary owner from cash calls, recourse loans, many landlord liabilities, creates a delegation of management, eliminates franchise tax and provides the availability of indemnification.

Free Landlord Consultation

When you have rental property for sale, give us a call or schedule a free consultation. Our experiences with landlords could be beneficial to you and yours.

7Affordable Care Act of 2010