8 Tips for Selling a Rental Property: Navigating Taxes and Tenants

1. Don’t get blindsided by hefty capital gains taxes.

When you sell a house that’s functioned as your primary residence, any net proceeds are usually tax-free. Generally, you can make a profit of $250,000 (if you’re single) and $500,000 (if you’re married and filing jointly) without having to pay any taxes. However, there is one big caveat: You must have owned the house for two years and lived in it for two of the past five years.

However, the IRS doesn’t extend the same generous tax breaks to real estate investors — different rules apply if you’re selling a rental property.

Most likely, your rental property has increased in value over time, resulting in a capital gain (the profit you earn when you sell). But since you’ve been renting the property rather than living in it, you won’t qualify for the “use test” of the capital gains exclusion, meaning that any profit you make, even under the $250,000/$500,000 threshold, could be taxable.

If you’ve owned the rental property for just one year or less, the profits will be considered short-term capital gains, which are taxed at the same rate as your income. That means depending on your tax bracket, you could owe anywhere from 10% to 37%, per the tax code as of this writing.

But if you’ve owned the property for more than one year, the long-term capital gains are taxed at a lower rate, ranging from 0% to 20%.

If your taxable income is less than $47,025 (single) or $94,050 (married filing jointly), you’re off the hook for paying capital gains taxes. But even if you earn more than that, there may be workarounds to avoiding them (read on to learn more).

2. Defer capital gains taxes with the 1031 exchange.

Maybe it’s time to unload a poor-performing rental property in a declining neighborhood, but you want to try your luck in an up-and-coming area. With the 1031 exchange, you may be able to sell one property and then buy another “like-kind” property with more income potential, without having to pony up the capital gains tax.

What exactly does “like-kind” mean? Well, you can’t use the 1031 exchange to buy a personal residence that you intend to live in — it has to be another investment property that you plan to rent out or flip. And the clock starts ticking as soon as you’ve sold the first house: You have 45 days to find and identify up to three properties you’re interested in purchasing and a total of 180 days to close.

“In addition to the timing of the sale and subsequent purchase, there are many other rules that you must follow with a 1031 exchange, so the most important first step is to contact a qualified intermediary, whose job is to facilitate all aspects of the exchange and ensure that you follow all the required steps,” says Hughes.

3. Consider living in your rental before selling.

If you don’t want to use the 1031 exchange to parlay your profits into a like-kind property, another option is to move into your rental home before you sell. As long as you live there for at least two years, you’ll pass the IRS’ “ownership and use” tests, which require that you’ve:

• Owned the home for at least two years (the ownership test)
• Lived in the home as your main home for at least two of the past five years (the use test)

When you pass these tests, you’ll be eligible to waive capital gains taxes for up to $250,000 (if filing single) or $500,000 (filing jointly). However, if the rental property is an investment turned sour, you may be better off unloading it now to cut your losses.

4. Honor your lease period, or give tenants ample notice to vacate.

If your rental property is occupied when you decide to sell, one option is to negotiate with the tenants and offer an incentive for them to vacate. But if they’re intent on staying put, or if you have a good tenant and want to use that as a selling point, you’ll have to respect the terms of the lease.

In most states, the lease agreement will be transferred with the sale, and the new owner can only make changes after the current lease has expired. “If your tenant has six months left on their lease, then buyers will have to accept the lease agreement as part of their purchase,” says Robert Taylor, a residential real estate investor with over 20 years of experience renting and flipping homes in Cameron Park, California.

If your tenants are paying month to month, you can choose to give them notice to vacate. Check to see what the rules are in your state. In Taylor’s state of California, landlords must give a 30-day notice to tenants who have lived in the property less than a year, and a 60-day notice if they’ve lived in the property longer than a year.

5. Use a good tenant as a selling point.

Hughes points out that for some investors, an occupied property is preferable to an empty one. “If you’re selling with a tenant, remember that you’re marketing the property to investors only, so you should include information in the listing that investors will care about,” he says. These might include:

• How long has the tenant lived there?
• What’s the monthly rent?
• Is the rent paid consistently on time?
• Does the tenant cover any utilities?
• What security deposits, licenses, or other permits are in place with the lease?
• When does the lease expire?
• Does the tenant take good care of the property?

To keep your tenants happy and cooperative during the selling process, you might consider offering some type of incentive — perhaps gift cards or discounts on rent — in exchange for keeping the property looking its best and being amenable to showings.

6. Evaluate the property for needed repairs.

It might be tempting to get a rental property off your hands as quickly as possible by listing it right away, without lifting a finger. And you might get lucky enough to find an investor who wants a house that needs some work in exchange for a better deal — but it could be worth your while to fix that leaky faucet, jammed window, or creaky door before you sell.

“Generally speaking, a clean, updated home sells for a higher price than a rental property in need of repairs,” says Taylor. “However, the cost of lost rent, repairs, and other expenses can often exceed any profit you may have made fixing up your property to sell it.”

If the house is vacant, Hughes believes it’s worthwhile to bring it to “modern rental standard” — including hard-surface floors, fresh paint, new blinds, light fixtures, and so on — so that buyers understand there will be no work to do before placing a tenant.

When deciding whether to spend the time and money on a repair before listing, ask yourself these questions:

• What’s the condition of the real estate market? Is it a low-inventory seller’s market, where buyers are more likely to forgive undone repairs, or are you competing against many other properties at your price point?
• Will you need to work around tenants to make the repairs?
• Do the repairs require the property to be empty, thus sacrificing rental income?

As long as you’re not doing a 1031 exchange, any repairs you make on a rental property — defined by the IRS as “expenses to keep your property in good working condition but that don’t add to the value of the property”— will typically be tax-deductible. The key is to know the difference between “repairs,” which can be immediately deductible, and “improvements,” which the IRS treats differently because they’re seen as adding value.

“For example, if you replace the roof of your rental, the IRS considers that an improvement that must be depreciated over several years,” explains Taylor. “But if you make a repair by replacing some flashing or roof shingles, that could be considered a tax-deductible repair.”

When in doubt, consult a skilled tax professional for clarity.

7. Don’t count on rental income to drive up the price.

While a good, well-paying tenant could make your single-family property more marketable to investors, don’t expect it to inflate the value.

“Single-family rental homes are appraised just like any other single-family home,” says Taylor. “But if your rental property falls under the classification of multi-family housing, meaning it has five or more units, your appraisal will be based on the rental income.”

That means raising a tenant’s rent won’t have an effect on the appraised value, but it could make your property more attractive to investors looking for reliable rental income.

With investment property sales, it’s more important than ever to make sure all the i’s are dotted and the t’s are crossed. The No. 1 reason for California lawsuits is lack of disclosure. An agent will fill in any gaps the seller might not know to disclose to avoid having a claim coming from the buyer after closing.

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  Thor Sorensen Real Estate Agent at Century 21 Affiliated

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  • Years of Experience 22
  • Transactions 507
  • Average Price Point $533k
  • Single Family Homes 384

8. Hire an investor-savvy real estate agent.

It might be tempting to try to sell your rental property on your own, but the marginal amount you’d save on commission costs (about 5.8%, per the national average) could pale in comparison to the higher price that a real estate agent would fetch.

According to the 2023 National Association of Realtors Profile of Home Buyers and Sellers, the typical FSBO home sold for $310,000, more than 25% less than the $405,000 for agent-assisted home sales.

To get an even bigger advantage, consider looking for an agent who specializes in working with investment properties. They will be able to offer expertise or insights on:

• Rent trends in your area
• Tax implications of selling a rental
• Projected return on investment
• After-repair value (AVR) of your property
• A network of investors seeking properties like yours

Thor Sorensen, a seasoned real estate agent in Oceanside, California, points out another important advantage of working with an agent: disclosure expertise.

“With investment property sales, it’s more important than ever to make sure all the i’s are dotted and the t’s are crossed,” he says. “The No. 1 reason for California lawsuits is lack of disclosure. An agent will fill in any gaps the seller might not know to disclose to avoid having a claim coming from the buyer after closing.”

One example Sorensen cites is the increase in fire hazard areas in California, which can create challenges with procuring the necessary insurance.

Are you not sure where to find an agent who specializes in rental sales? HomeLight’s Agent Match can provide a custom list of recommendations tailored to your area and property type.

Top agent tips to help you sell your rental property

Sorensen has sold many rental properties throughout his 20-year career. He offers these bits of advice for sellers who are considering hanging up their landlord hats.

If possible, vacate the property before selling.

Ideally, Sorensen prefers to have the rental property vacant before prepping it for sale. That’s because these days, buyers feel more comfortable with purchasing an empty property and then renting it out to someone else who they can vet on their own. “After the eviction moratoriums that transpired during the pandemic, buyers are afraid they will inherit a bad tenant and then have to go through the process of evicting them,” says Sorensen.

Selling a vacant rental also means it’s easier to make any necessary repairs or renovations and to stage the property for showings — and you won’t have to worry about working showings and open houses around the tenant’s schedule.

If selling with existing tenants, be diplomatic.

If you need to sell a property before the tenant has vacated, Sorensen stresses the importance of being as kind and accommodating as possible. With California laws giving tenants more rights, he warns that tenants can make life difficult for the seller and the agent if they feel they’re not being treated fairly.

Give plenty of notice before showings, consider hiring a lawn service and/or cleaning company to keep the property show-ready without putting that burden on the tenant, and notify the tenant when the property sells.

Don’t overlook staging and prep.

Sorensen says that with more competition starting to emerge on the market, it’s more important than ever to make sure a rental shows well. “The condition of a listed property is suddenly really important again,” he says.

Recently, Sorensen showed a rental listing to a buyer. The tenant was still occupying the property, which hadn’t been cleaned and was filled with boxes and clutter. “It was a $1.5 million home, but it didn’t show well and didn’t give the buyer a good first impression, so they didn’t make an offer,” he says.

It is possible to sell your single-family rental property and still maintain your sanity. If you’re not sure where to start, connect with an experienced real estate agent who can help you determine the property’s value and asking price, assist with staging and preparations, and market the rental to the right buyers. Along the way, you just might find your next rental investment waiting in the wings.

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