Need an Exit?

2021 Landlord Options for Less Tax and Cash Flow

It’s no secret that we have massive challenges for the residential rental market in Washington State. Even if your tenant is paying, currently you cannot increase the rent, and it’s almost impossible to evict someone for lease violations. Under these circumstances, it’s very difficult to properly manage properties, especially if a large portion of the tenants don’t pay. Troublemakers and increased repair costs have also added to the weight the landlords must bear.

These challenges have many landlords considering their exit strategies. Most have experienced nice equity gains as the market has pushed up the last decade. Despite the moratorium, with demand strong and interest rates at historic lows, you can get a great price for your rental property should you choose to sell.

Option 1:

Put your portfolio on the market and sell it. Going this route would likely produce the highest tax obligation and fees paid. Then it’s your responsibility to put your money into a safe investment that will provide you a monthly income! This option is preferrable when you need a full, immediate cashout. For instance, if you’re paying off your house or selling a building that you’ve only owned for a couple years with no significant gain, this may be the best option. (Of course, always check with your CPA).

When you have owned rental real estate for quite a few years, the challenge is the tax obligations, specifically depreciation recapture and capital gains. Often landlords tell me, “with all these new regulations and tenant issues, I want to sell, but I don’t want to pay large tax bills and big commissions. I use this income every month!” That’s when an alternative strategy may work best.

Option 2:

If you are ready to move on to a more passive income stream with much less liability, consider selling and holding the contract, just like a bank! For example, you can sell your property (or all of them), get the down payment you want for cash today, and receive the balance, plus a whole lot of interest over time as monthly cash flow! The beauty of this strategy is that you will only be taxed on the down payment in the year of sale! The lion’s share will be deferred or eliminated. Instead of paying all that extra money to uncle Sam, it is yours to keep and make interest on! Your money is secured against the real estate and earns interest for you every month as cash flow! For my CPA friends out there (or if you take this strategy to your CPA), I am referring to the part of the tax code called “section 1250 unrecaptured gain” as it pertains to “installment contracts”.

Let me give you a real-life example of some landlords we were able to help with this strategy. John and Marcy S. (see www.easyapartmentsell.com for their video interview) owned 3 buildings, totaling 22 units. Marcy had long since retired from her day job but still helped with the rentals. John was a mechanical engineer getting ready to retire. John was managing the buildings himself and trying to keep up with all the new regulations, maintenance, and tenant issues. John started to think about the next chapter of his life beyond active ownership.

John and Marcy had owned the buildings for 21 years, so they were staring down the barrel of a large tax bill between capital gains and depreciation recapture. John was also not really excited about paying 6% of the gross selling price in real estate commissions. After talking to his CPA but before listing with a real estate broker, John called me and asked if I wanted to “take a look at them and make him an offer.”

I made John an offer that fit his needs on all 3 buildings. He sold them in one transaction and paid zero real estate commissions. But it got a lot better for John and Marcy from there! John wanted to buy a new Corvette! He didn’t want to take a huge down and create a big tax liability, so we agreed on a down that would give him the money to buy a new Corvette, cover what little tax obligation he might have, and put a couple bucks in his pocket for a rainy day. We also agreed on a monthly payment that would cover all their bills and support a lifestyle with some travel.

The result was John and Marcy saved over $100,000 in taxes that they would have otherwise owed if they were cashed out. That tax savings created an additional $525 per month cash flow totaling an extra $168,273 in equity and cash flow ($100,000 tax deferred, $68,273 interest on those deferred taxes). This doesn’t even include the savings of not paying commission! That’s awesome but not the best part! The best part is that since John was retiring the next year his tax bracket dropped from 33% to 10%. This means most of the tax obligation was permanently eliminated! Instead of paying that tax, they accomplished the extra cash flow, protected their equity, and got rid of most of the tax obligation they would have had if they cashed out. Now they have a monthly income for the rest of their lives!

Option 3:

1031 out of residential real estate. Is there another real estate asset class you’re interested in? Self storage or agriculture maybe? You could sell your residential rental property and do a 1031 tax deferred exchange into a different investment type. These of course require active ownership and liability. You can defer 100% of your tax obligation this way! Just understand with the 1031 tax deferred exchange that you are pretty much kicking the tax obligation down the road, so further tax strategy will be needed. It’s always best to check with your CPA to see how advantageous the 1031 tax deferred exchange would actually be for you.

Option 4:

Under current tax code, you can hold real estate until you die with your heirs getting a “step up in basis” at the time of your passing. Currently, their “basis” for tax obligation gets stepped up to the current market value at the time of passing. *Warning here* Make sure if you go this route you cover two things 1. The operations of the investment as it pertains to the heirs. Do they know how to run it? Do they want to run it? Make sure they are involved when you are healthy and can show them how to manage the property they will be inheriting. 2. Make sure from a liability standpoint that you are bullet proof. One advantage to passive investments is that you’re not legally liable for operational or tenant issues, so make sure you protect yourself if you choose to hold the property the rest of your life!

The point is that there are a variety of options for exiting the active ownership of landlording and ways to save taxes doing it. There are options which reduce your taxes, allow you to keep a monthly income, defer taxes, pay zero real estate commissions, and you don’t even have to do repairs or deal with tenants. There are various options to consider.

If you are considering selling or like the idea of passive monthly cash flow, then call 509-414-5123 or visit www.easyapartmentsell.com  We have helped many real estate investors with their exit strategies, and we never charge the seller a penny! Our mission is to help you achieve true freedom through cash flow.

Tyler Vinson

Investment Real Estate Expert