Want to Unload That Investment Property? What Advisors Recommend.

Especially coming out of the pandemic, many older people may not want to deal with being a landlord anymore, having to perform tasks like rent collection and property management, says Rob Johnson, head of wealth management at Realized. 

While now could be a great time to exit with valuations so high, there are multiple things to consider before you just up and sell. Here’s what financial advisors are telling clients.

Think ahead. Anyone considering selling an investment property should consult with tax, financial, and real estate professionals before making a decision. Ideally, these discussions will take place before the property owner retires to leave enough time to properly strategize, says Nell Cordick, senior vice president and financial advisor at Bogart Wealth, which has offices in Virginia and Texas. 

A major factor in these discussions should be taxes. “When people haven’t done the proper tax planning ahead of time, they are shocked at the tax results of selling an investment property. What they thought would be their net [proceeds from the sale] is much, much lower because of the tax consequences,” she says.

From a tax standpoint, you’ll want to consider the ramifications of selling the property outright versus other tax-favorable options such as a 1031 exchange, which offers several benefits, but also requires strict adherence to IRS regulations. 

Timing of a sale can also be important from a tax perspective. Selling in a year when other sources of income are low might be a good option, she says. If you’re over age 63, you’ll want to mull over what effect, if any, a sale will have on your Medicare bracket, she adds. 

Beyond taxes. It’s also important to understand how a sale fits into a client’s overall real estate strategy. Some owners, for instance, may choose to sell high, even with the tax consequences, because they think there will be a correction where they can buy low and then go through the whole process again, Cordick says. Others might simply want out of owning an investment property and are willing to accept the tax consequences to avoid the emotional hassles, she says.

Here are some questions advisors should ask, says Jody King, director of wealth planning at Boston-based Fiduciary Trust. 

Does the client want to continue being a hands-on landlord, or do they prefer a more passive role? If they like being in the property management business, how wedded are they to this particular property? Will it hold its value or might it be advisable to sell now and find another property in a more desirable location? How important is the cash flow to your retirement, and how will you replace it, if it’s necessary to maintain your lifestyle? 

Run through the possibilities. For clients looking to remain in the investment property business, there may be several options. For those who want to manage their tax liability, one option could be to sell their current investment property and purchase another property through a 1031 exchange. This strategy allows investors to defer capital-gains tax on the sale of their investment property, if strict rules are met. For instance, they have to identify a replacement property within 45 days, and complete the exchange within 180 days. 

For owners who want to take less of an active role, but still want the tax-deferral benefits of real estate ownership, there’s the option of a Delaware Statutory Trust, or DST, which are professionally managed portfolios of commercial real estate. DSTs offer investors fractional ownership of commercial real estate properties, but all of the management responsibilities are pushed to a sponsor, says Johnson of Realized. 

Some DSTs have one property, while others have more than 20 properties within their structure. Investors can also diversify by investing in multiple DSTs, he says. “Having a diversified portfolio in retirement is essential because you don’t want to take undue risk or overconcentrate your portfolio to just one property,” he says.

Some clients may also consider selling their property and investing in an Opportunity Zone Fund, an investment program created by the Tax Cuts and JOBS Act of 2017 to give tax advantages to certain investments in lower-income areas. Investors roll their gain on the sold property into the Opportunity Zone Fund where it will grow tax deferred until 2026, says Brad Levin, managing director and senior wealth advisor at The Colony Group. There are many available funds of this nature set up by real estate investment companies, he says. 

Another option for clients with charitable inclinations is to transfer the property before it’s sold to a charitable remainder trust. The gain that’s realized upon sale is then exempt from capital-gains tax. The proceeds can be reinvested and the investor receives income from the trust for their lifetime, and when the individual dies, whatever’s left goes to charity, Levin says. 

“It’s not just about tax savings or not. There are a lot of different pieces to it, and you have to understand the whole picture before you can advise,” says King of Fiduciary Trust. 

Keep in mind that emotional attachments to properties can change the picture. Does the client want to keep the property in the family? And if so, what’s the most appropriate way to initiate a change of ownership? How important is the cash flow to your retirement, and how will you replace it, if it’s necessary to maintain your lifestyle? 

While there’s no one-size-fits-all solution, advisors can help clients wade through the pros and cons of the various options. “It’s the advisor’s job to present the options and allow the client to make decisions based on those options,” King says.

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