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Lesson 8 - Disposing of Property
Many of the aspects
of buying an income property are also important when selling one. One just
views things from the other side of the transaction. We won't, in this lesson,
try to deal with every issue from the other side because it should be obvious
what the other side is of all issues discussed in the previous lessons, but we
will discuss some of the more important ones.
Why Do It?
There are, in general, two possibilities. First, because you have to
do it and second, because you want to do it.
By "have to" we mean you need
to sell because of health or some other reason that limits your ability to
pick the market conditions in which to sell. "Want to" covers all cases
other than "have to" no matter what the reason, be it that you're tired of
the business, want to retire with the freedom to travel, or want to utilize
your equities to enjoy the lifestyle of the rich and famous. The major
difference from "have to" is that you have more flexibility as to when you
do it.
When To Do It
Like many other things in life, timing the disposal of your property is
important. The time to dispose of property is when it's a seller's market, that
is when the the demand is higher than the supply. Unfortunately, real estate
investors must often dispose of property under less than ideal circumstances for
reasons of health, divorce, or general financial condition. However, even when
you "have to" dispose of property, following the correct procedures will help
you realize the highest possible return.
How To Do It
You have several options regarding getting rid of a property. You can
give it away, you can sell it, or you can trade (exchange) it. There are also
two other ways. One is to stop paying your loan payment or your property taxes
and have it taken away, but this option doesn't require instructions. The other
is to die and leave it to your heirs, and, while no instruction is usually
necessary for the dying part, proper estate planning is recommended.
Gift It
There are several reasons why you might consider giving it away. One would
be to gift it to a family member or friend. Gifting to relatives or other
individuals or entities (other than charities) can have an impact on overall
estate planning Another would be to donate it to a charity. There are even
ways to put a property into a charitable trust that allow you to retain control
even as to future use long after your demise. All of these possibilities have
tax consequences and require that you seek competence legal help.
Timing of a gift can be important because the stepped up basis for the recipient
is related to the value at the time that the gift is made. If gifting to a
tax-exempt organization, timing has no tax consequence, but there could be other
issues. RHOL's Buying & Selling
Income Property e-Course has a discussion regarding charitable trusts.
Sell It
You can, of course sell the
property, just as you can sell your personal residence. And, just as when
selling your personal residence you want to maximize the sale price. However,
selling income property is usually more complicated and can have significantly
more tax consequences.
Selling an income property involves many of the same issues as buying one,
except from the other side of the fence, and having completed the previous
lessons, you certainly realize that that buying can be a bit complicated.
One of the most import tax consequences is that taxable gain will be based
on sales price (less selling costs) less your basis at the time of sale. In
other words you will pay tax on all the depreciation that you deducted during
the years of ownership in addition to paying tax on the actual increased value.
There are ways to somewhat cushion the
tax blow, for example, by structuring the sale as
an installment sale, but further details are a subject for a future e-course.
Timing is obviously important for
selling a property because you'd like to sell at the top of the market or at
least not at the bottom. If in an increasing market, you might want to delay
the sale if practical and add more dollars to your price, using that time to
maximize rents and minimize expenses where ever possible.
Exchange It
Unless you want to get out of the landlord business, it will usually be
advantageous to exchange your income property under Section 1031 of the Internal
Revenue Code. The exchange also provides a means of trading your existing real
estate portfolio for one that is less management intensive when you want to slow
down, but not entirely retire from the rental business. While this is sometimes
referred to as a "tax-free' exchange, it is in reality a "tax-deferred"
exchange. The main advantage of a tax-deferred exchange is that it allows you
trade up to larger property or higher quality property after your previous
property has increased in equity in order to improve your leverage position,
utilizing untaxed dollars to do so. As indicated by the word deferred, you will
eventually have to pay the piper if you wish to cash out and retire from the
landlord business. However, there are ways to cushion the blow, one being
to die and leave it to your heirs.
Marketing
Many of same
issues are important in selling the property as were important in buying it.
Selecting an agent, maintaining control over the deal, setting the price, being
careful about contingencies, etc. However, everything is from other
side of the fence. If things are not to your
advantage as the seller (maybe the buyer completed this e-course), try to change
them in your counter offer. For example, try to get contingencies worded so
that each one is approved if written disapproval is not given within the time
period and make time periods as short as possible.
Using An Agent
Most of the same
considerations, as were discussed in Lesson 3, apply when selling an income
property as when buying one.
Pricing
To determine what
your property is worth when it's time to sell, you follow the same procedures as
when you bought it as discussed in Lesson 3 of this course or as covered in much
more detail in our
Valuing Income Property e-Course.
Preparation
Take care of all physical and legal problems regarding the property that
might be considered an issue by a buyer. Having them become an issue in the
middle of a deal can result in cancellation of an escrow or re-negotiation of
the price or other terms. Physical issues include inoperative sprinkler
systems, out-of-code electrical or plumbing systems, and cracked windows.
Legal issues include tenant disputes, building code violations, delinquent
taxes, and missing licenses or permits. If there are any
problems regarding inability to obtain legally required licenses and permits,
get them resolved before putting the property on the market. On reason to take care of these issues
before even putting your property on the market is that some might suggest to a
savvy buyer or agent that you are having financial difficulties and could result
in lower offered prices.
Also consider various relatively inexpensive cosmetic upgrades that might
make a difference. Exterior painting, cosmetic landscape improvements,
re-coating of asphalt. and repairing superficial defects that make the property
look ragged can have a significant impact on potential buyer's initial reactions
even to the point of writing the offer.
Documentation
Be prepared to provide the same documentation when you sell as you should
have required when you bought, as discussed in a previous lesson.
Legal Issues
If there are any issues regarding zoning or building codes, it is best to
disclose it up front so that it doesn't become an issue two months into the
escrow where it could either kill the deal or require re-negotiation of the
price. If there are things that you can't fix ahead of time, it is best that
they be considered in negotiations up front rather than after everyone is
expecting escrow to close.
Selling It
Counter Offers
When you are selling
your property it will be the buyer who will be writing the original contract
terms and they will likely be written to his advantage. It is almost certain
that no offer written by the buyer and/or his agent will be ready for the
seller's signature. You should be particularly concerned about certain items
and should try to change them to you own advantage or at least make them
neutral.
There are a number of general principles that you should follow when
trying to modify contingencies in your counter offer.
- It is to the seller's advantage
to that all contingencies are automatically approved if not disapproved in
writing.
- As we recommended for you are
the buyer, it is usually in your best interest as the seller to require the
buyer bear the cost of inspections and then take that fact into account in
deciding the minimum price your will accept. The reason for this is
two-fold. First, it is usually better that the vendors to be hired as the
agents of the buyer rather than of the seller for obvious reasons. Second,
you want the buyer to be responsible for timely completion of inspections and
not be at fault if a contingency is not met in a timely manner.
- Rather than wanting maximum
time for contingency periods as you do as buyer, you want to be sure that the
requested periods are not unreasonably long to avoid them being used to buy
time for a non-performing buyer. If the buyer requests a time that is too
short, that's his problem and you can always give him additional time if
desired..
- To the degree possible,
schedule inspections in order of importance relative to decision making in
order to have the cancelled as soon as possible if there are problems.
Financing
Be sure that all specified terms including maximum interest rate, discount
points, and other costs as well as the minimum number of years of the loan are
realistic in terms of the current market, with room for probable changes.
Financial Records
The value of the property and the amount that a buyer will be willing to
pay for it are entirely dependent upon the income and expenses so you should
expect to provide sufficient financial documentation to enable the buyer to make
his decision.
Lease Documentation
Provide good readable copies of all leases and other documents, including
amendments, checklists, and house rules so that the buyer can provide copies to
lenders rather than you having to make additional copies.
Physical Inspections
As stated elsewhere, you should have taken care of any deferred
maintenance before putting the property on the market, so that physical
inspections don't find serious defects that haven't been disclosed.
Survey
A boundary survey is
seldom needed and if desired, should be buyer's responsibility and at his
expense.
Environmental
Is the property in a super-fund site? If so, disclose it up-front and
don't allow the fact to be a contingency.
Do you have a previous Phase One Report? If so, provide a copy and
require the buyer to accept it without contingency.
For a residential property built before 1978, provide copies of executed
lead-based paint disclosure forms for each tenant. Also, provide the buyer with
the legally required lead paint pamphlet and disclosure form and any required
related documentation.. This is in addition to providing him copies of the
tenant-signed forms.
If you've had Radon testing and/or abatement done, provide the appropriate
documentation.
Estoppel Certificates
Although it is for the buyer's benefit that estoppel certificates be
required, they can also benefit the seller because they eliminate potential
disputes by buyer or tenants as to rents, deposits, and other lease terms. You
don't want a tenant arguing the terms of his lease or some other matter after
close of escrow.
Other
Do not accept any contingencies that are impossible. For example, do not
accept a contingency that all air conditioners be in operating condition when
you know that some are not, unless you are prepared to repair them, in which
case you should have done so before even putting the property on the market.
Escrow Length & Restrictions During
Period
Be sure that the requested closing date is realistic based upon the time
required to complete all contingencies including financing. Although you, as
seller, want to close as soon as possible, it is extra hassle to grant
extensions because the original date was unrealistic. You should not worry
about restrictions regarding what you can do during the escrow period unless the
buyer does. In the case he does, try to limit the restriction if possible,
remembering that you don't want to limit your control more than necessary when
there is never a guarantee that the deal will close.
Tenant Notification
Since you will want cooperation of tenants regarding buyer inspections and
estoppel certificates, it is recommended that you notify tenants of the pending
sale as soon as there is a fully executed purchase contract. You should explain
that the buyer or his agent will be making inspections and thank them in advance
for their cooperation. Keeping tenants in the loop and remaining on good terms
with them may reduce the chance of them voicing complaints about the property to
the buyer or his agent. Not only does this reduce the chance of defects
becoming more important, but it also is best that the tenants appear to be
happy.
Contingency Cooperation &
Assistance
Although you might resent the
need to assist in getting access for inspections, it is again to your advantage
to cooperate and even assist in getting the contingencies out of the way as soon
as possible and with the least amount of trouble. Again, your presence when the
buyer or his agents are interfacing with tenants may reduce the chance of them
voicing complaints about the property to the buyer. You might even want to be
the one to get signatures on estopple certificates so that you can deal with any
misunderstandings or disputes yourself rather than have the buyer or his agent
involved.
Transfers & Terminations
Licenses, Permits & Taxes
Be sure that you inform the relevant governmental agencies that you have
sold the property so that you don't end up being liable for the new owner's
failure to pay fees or taxes.
Insurance
You will want to cancel insurance coverage after closing escrow.
Pro-ration of insurance premiums are usually to the effective date of sale of
the insured property rather than to the date when notice is given, so there is
no reason to jump the gun and risk cancellation prior to the date of ownership
transfer. Doing so could result in an uninsured loss resulting from either a
physical loss or a liability claim because closing was delayed and the insurance
agent didn't get the word that coverage needed to be continued beyond the
previously scheduled closing date.
Utilities & Miscellaneous
Services
While you don't want to discontinue utilities or other services prior to
closing escrow, you do want to be sure to do so immediately thereafter. You
should coordinate this with the buyer to avoid disruption of services to tenants
and this issue might even be covered in your purchase contract. It's a good
idea to follow up with phone calls after the discontinuance date to verify that
it actually happened.
After Closing
Check the closing statement carefully. In particular check pro-rations of
rents, property taxes, and interest and be sure that you are correctly debited
for deposits and that the loan payoff amount is correct.
Send written notice to all tenants that escrow has closed and provide the
name of the new owner and his address and phone number.
File the closing statement where you will be able to find it when it's
time to prepare income tax returns for the year of sale.
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