Rental properties are a great way to generate passive income. As long as you’re working with a competent property management company that can take care of the maintenance and rent collection duties for you, you can simply watch the money come in without so much as lifting a finger.
As a property owner or investor, the more properties that you have under your wing, the higher the rental income that you generate will be. In other words, the first thing that most investors do when they get the necessary funds is to increase the number of properties that they own.
With all of that said, the premise that you should sell your rental properties at a loss might sound to you like we’re listing good reasons as to why you should toss your money in a fire and watch it burn up. But give us a chance to explain, and you might see why a loss on sale of rental property can sometimes be beneficial.
Why should you sell your property?
The most compelling incentive as to why you should think about getting rid of a property is because it isn’t generating enough income. The reasons might range from unruly tenants, to rent price drops in the area, or the maintenance costs far outweighing the rent fees that are being charged for the unit.
There are of course ways that you can combat all of these problems. You can tell your property managers to implement certain tactics in order to ensure that the rent payments will be collected on time. You can bring up the maintenance costs to the property managers, so that you can develop a strategy to fix the unit without much financial loss. You can even reduce the chance of getting unruly tenants by simply creating some stricter tenant requirements.
However, while you are coming up with all of these plans and strategies for improving the value of the property, you might come to a point where you realize that it really isn’t worth it. You might come to the conclusion that these are at best just stalling tactics to avoid the inevitable, and that the property in question isn’t worth the man-power and the effort.
If you do reach that conclusion, then the only thing left to do is to start the procedure of marketing and selling the problem property.
How do you know if you’re selling at a loss?
The cost basis of a property is the price that was paid when the unit was acquired, plus the associated closing costs and the price of any upgrades that were made to the property after the initial purchase. But you should know that any maintenance and repair costs for the unit don’t count as upgrades, meaning that they aren’t included in the cost basis.
The calculations are straightforward really. You calculate all of the above-mentioned fees and factors and subtract the price at which the property was sold, or is estimated to be priced at currently.
For example – if a property was purchased for the price of $80,000, and $15,000 were spent on making some necessary upgrades, with an additional $5,000 being spent on the closing costs, then the cost basis of the property would be an even $100,000. These sums don’t reflect any actual prices but are rather taken as an example for a nice even number that we can use to explain our point.
If the property has depreciated in value (which it almost certainly has), and you estimate the current going rate to be $90,000, then you will need to subtract the current selling price form the cost basis in order to arrive at the loss that you’ll be facing. In our case, we subtract the 90 from the 100 in order to arrive at a loss of $10,000.
Are there any benefits to selling a property at a loss?
As we mentioned before, the best reason to sell a property is if it isn’t bringing in a steady income, but is rather nothing more than a drain on finances due to the constant maintenance costs. There is however one further incentive for selling a property as opposed to holding on to it and having it waste money – the tax deduction.
Capital loss and capital gain are the difference between the cost basis and the selling price of the property. For example, if a property has a cost basis of $50,000, but it was sold for $45,000, then it accrued a capital loss of $5,000. If a property had a cost basis of $50,000, but it was sold for $55,000, then it had a capital gain of $5,000.
Selling a rental property at a loss will allow you to use the capital loss you obtained from selling one property in order to offset the capital gain that you may have obtained from selling another. This will allow you to reduce the tax amounts that need to be paid for the property that was sold for a capital gain.
Selling a rental property should never be the first course of action. A lot of maintenance issues are easily solvable, and tenants can be evicted if they aren’t following the guidelines of their lease agreements. Meaning that there are steps that you can take to improve the situation, even if the unit in question is currently in bad shape.
However, if it ever does get to a point where the costs are so high that it doesn’t pay off to maintain the property any longer, then it’s good to know that selling the property at a loss has a tax deduction advantage that you can use to turn a bad situation into an advantage for the next property you sell.