The right time to sell a rental property

Consider the tax liability currently versus in the first year of retirement

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Q: We have a rental property that provides a decent return, but we are tired of the responsibility and wish to sell it. I am still working for another few years and there will be sizable capital gains. My questions are: Should we sell the property while the market is hot (and before interest rates climb) or wait until I retire? And what could we invest in with the equity?

 – Sydney

A: I’m afraid there is no one-size-fits-all answer in your case, Sydney, but I’ll try to provide some issue identification and discuss some potential solutions for you.

First off, the tax on the sale of the property will come from two sources: capital gains and recapture. It’s clear that the property has gone up in value, so there will be a capital gain on sale. The gain is determined based on the sale price, less selling costs (like real estate commissions and legal fees), less the adjusted cost base (ACB) of the property. The ACB isn’t necessarily just the original purchase price – it may be that you have made capital improvements or renovations over the years that have increased the cost of the property for tax purposes. Eligible closing costs on the initial purchase will also add to the ACB.

One-half of a capital gain is taxable and could be taxed at over 50% depending on your province of residence and other sources of income in the year. No doubt your income is likely to be higher during the next few years while you are working, so that needs to be taken into account as far as determining the timing. You might want to look at the tax liability currently versus in the first year of retirement, for example, to see if it’s compelling enough to hold off, Sydney.

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In addition, recapture may apply if you were claiming depreciation on the property over the years. Depreciation provides a 100% deduction against net rental income when claimed, but on sale, all accumulated depreciation is 100% taxable. It too may be taxable at a tax rate of over 50% depending on your income sources and where you live.

You raise a good point, Sydney, about interest rates. You are concerned about the impact on real estate prices if and when interest rates rise. There’s not much room for interest rates to fall and eventually they will increase again, but it may be some time yet. All assets prices are at risk when rates rise and the cost of borrowing is higher and fixed income investments like bonds and GICs are more competitive. I personally think that the low rate environment and the real estate market may still have some legs.

As far as how you invest the proceeds if you sell the property, you could consider other types of real estate investments if that’s an area of interest for you. There are a wide variety of publicly traded and private options ranging from owning real estate indirectly through real estate investment trusts (REITs), various funds and limited partnerships (LPs) to loaning on real estate in the form of mortgage funds or mortgage investment corporations (MICs).

I think you really need to look at your overall investments to see how the proceeds best fit into your portfolio. And with retirement approaching, Sydney, a retirement plan can help you project and determine your required rate of return in retirement, your income needs and how much of your capital you need and when.

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Jason Heath is a fee-only, advice-only Certified Financial Planner (CFP) at Objective Financial Partners Inc. in Toronto, Ontario. He does not sell any financial products whatsoever.

4 comments on “The right time to sell a rental property

  1. IMHO, as a rental property owner, the right time to sell the property should not be dictated by tax issues. Although tax issues are how financial planners prove their value by listing facts and figures not readily available to a consumer, they are only one consideration, especially with an illiquid investment like rental real estate where the owner is personally engaged. These folks will have to settle eventually, and tax paid later is better than tax paid now to be sure. But a decline in value can be precipitous and the trough can be enduring. If the property is not appealing it can languish. Unlike other investments, five or ten more years of owning a property means a 5 or ten year older roof, furnace, etc. These clients should ask themselves if they are prepared to hold the property for 5 or ten years, because that is what may be required if housing tanks. The taxes are what they are. They will be less later on perhaps, but remember all those folks who held on to their Nortel shares while the market tanked: they don’t need to worry about capital gains *now*, do they?

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    • @David… what part of “I’m afraid there is no one-size-fits-all answer in your case, Sydney, but I’ll try to provide some issue identification and discuss some potential solutions for you.” didn’t you understand?

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    • Oh, yes on the “financial planners prove their value” part, our job is to bring all the considerations up so that the client can make an informed decision. Whether the taxes are less or more is not necessarily relevant, the income of the seller(s) is relevant. So while there is not enough info here to really go into detail…..thus “I’m afraid there is no one-size-fits-all answer in your case” answer. And what do Nortel shares have to do with real estate? Apples to apples please….

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  2. As a reader I am shaking my head at the comments made to date. Public forums seems to bring the silliness and fighting nature out in people.

    As an accountant I would like to make some factual comments on the article. The bottom line is that the hard crunching of numbers and decisions based on this are the easy part. The examination of the soft issues like the future of the real estate market and rental market are less than easy.

    I can easily sit down with the numbers and determine the tax implications and come up with an argument for or against disposition. I can also take the facts of the property and develop a rough budget of what major repairs the future may hold.

    After owning several rental properties I can tell you that trying to assess what the market holds is much more difficult. Where is the market value of the a rental property going to be five years from now, let alone looking out on a ten year timeline? As well, I have seen neighbourhoods change within the five year timeline, and not in the positive direction that had been expected. I have also seen rental markets change practically overnight in some cases. A good case in point was Fort McMurray before and after the collapse of oil prices. I wish I had been able to see that one coming! Unfortunately my crystal ball does not seem to work that well. This is also a good case of how external forces can impact rental properties. All these are things to consider when deciding to time selling. In retrospect I should have known better and taken my large capital gain off the table, pay the taxes and wait for another opportunity since all things move in cycles including the price of oil. I will label myself greedy and dumb in that case.

    Due to the fact my aging father and I owned this portfolio of rental properties with mortgages outstanding on all of them, when his health began to decline it was time to eliminate them. Part of this decision was also about the decreasing rental rates being collected and large capital expenditures being required for repairs. I missed the boat of raking in large capital gains back in 2007 before things went to hell for my properties and the economy in general. However, I put my accounting hat on and worked out a good solid plan to spread out the capital gains over two years that also worked into a plan for paying taxes while my income was lower. I methodically went through the seven properties and worked out a list of the order in which they should be sold. The reasons for this were based on shedding losers first and capturing gains on those that were losing value first. Then during the first year of this plan my father passed away. That threw my plan out the window. My tax position was still ok, but due to deemed disposition the final tax return for my father resulted in massive income tax owing due to enormous capital gains all being reported in that one year.

    Thus the thing is that even the best laid out plans can go to hell in a hand basket.

    CD

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