In some situations, a person may face a situation where they have additional property; perhaps they’ve inherited it, or they’ve recently moved out of a starter home into their forever home. Then, they’ll be faced with the question, to rent or sell an additional property?
It’s a question that involves thoughtful consideration — as it’s a big decision. Potential considerations may include. . .
One thing to consider when deliberating the question is taxes for selling and renting. Rental income is taxable at your regular tax rate; however, you can write off rental expenses . If you decide to rent and then eventually sell the rental property, there are also tax considerations, as taxes will be payable; the longer you own the property, the larger the tax payments may be.
First is a depreciation recapture tax, as owning a rental property allows you to depreciate the property’s value, reducing the taxable net income. When the rental property is sold, the IRS seeks to get this returned through recaptured depreciation, which is taxed as normal income at the normal tax rate.
Second, capital gains taxes occur when an asset is sold for any amount of profit, categorized as short or long-term. Short-term is a gain on a property held for less than a year and taxed at the same rate as regular income tax. Long-term gain is when a property is held for a year+; taxation is set at 0%, 15%, and 20% (2021), based on your income. There are ways for capital gains taxes not to be charged, but these would require certain aspects to be met.
To best understand the tax considerations associated with renting or selling a property, we always recommend that parties discuss with an expert in the field.
Need to Sell?
In most cases, if someone is already a homeowner, they use the proceeds from their current home to put towards purchasing their new home. If this is the situation, there is no question of whether to rent or sell.
Current Real Estate Market
The real estate market is ever-changing, with prices rising and falling as demand and supply ebb and flow. If prices are low, it may be better to hold onto the home until prices rise. However, if selling is the plan someone is leaning towards, and it’s a seller’s market, it may be better to sell right away — as there may be more involved with bringing it back to a presentable condition after tenants reside in the home.
It would be best to discuss with a local real estate agent when considering the current real estate market, as they can provide a better idea of it and the home’s saleability in the current market.
There are expenses to renting a home to weigh against the cash flow from renting out the house.
- Insurance (rising cost)
- Repairs (a certainty)
- Taxes (rising cost)
- Advertising (to find a tenant)
- Miscellaneous Expenses (because there always is)
There may also be additional expenses, like:
- HOA fees (if you are in an HOA that allows rentals)
- A real estate commission (if you are using a real estate agent to market the property for rent)
- A management fee (if using a property management company instead of doing it on your own)
Additionally, if any repairs or renovations are necessary to make the unit rental-ready, these are additional costs to consider before even getting started.
Adopting a Landlord Role
Managing a property can be time-consuming and present challenges; it’s more complex than collecting a rent check each month. There will undoubtedly be issues that require fixing, which will require you to roll up your sleeves or hire a contractor to make the fix. Landlords are also responsible for the big fixes, so money would need to be set aside in case of a significant problem. Additionally, you’ll be responsible for filling the home — screening potential tenants, and showing the unit. Finally, various legal obligations and responsibilities are associated with being a landlord that must be followed.
If you don’t want to be responsible for the property management (but still want to rent it out), you would need to hire a management company to do so — which is an added expense.
Alternatively, you could consider doing short-term rentals, provided your locality allows it; however, this can still be labor intensive. You’ll need to locate a cleaning company that can be on call for your bookings, furnish the home with the necessities (plus any extras to attract guests), manage the booking schedule, repair any broken fixtures, and deal with any guest problems. Again, you could hire a company to handle this all for you, but it will be an added expense.
Some homes just don’t make good rentals, whether that’s due to their location or layout. Additionally, some homes won’t generate enough rental income to cover the necessities: mortgage payment, taxes, insurance, and general maintenance costs.
Also, if you are in a condo association or HOA, some have rules against renting out residences — in which case, selling would be the only option.
You should also consider your own personal life plan when making the decision. For example, do you want to keep the home in your family for a future residence for you or a family member? Are you temporarily relocating for a job or emergency but wish to return to the area after? These may be circumstances where renting out the home to a suitable tenant for a time may be preferable to keep the house for a future date.
Overall, there are solid reasons to consider renting a home out, like:
- Building equity
- Diversifying assets
- Generating some extra income
However, there can be equally practical reasons for selling, like:
- Gaining money to put toward your next home purchase
- Avoiding the responsibilities of being a landlord
If you’re in a situation where you are considering the question of rent or selling, connect with a qualified tax expert and a real estate agent. These experts will be able to provide answers to some of these considerations. If you’re looking for some advice on the Lake Country or Southeastern Wisconsin real estate market, don’t hesitate to get in touch with one of our qualified real estate agents who will be able to assist!
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