From tax consequences to lifestyle goals and retirement needs, knowing the right time to give up your rental property is as individual as you are. Here’s what you should ask yourself
If you’re like many real estate investors, you likely bought an investment property over the past few years as a good way to boost your total returns as well as your overall wealth. There’s a whole industry built up around how to invest in real estate and it’s a lot of people’s preferred investment vehicle.
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Now, some would argue that the best time to sell your rental property is never. That way, you are protected for life against inflation — an ever-present threat that can erode the value of money over time.
But things change and you may be at a stage in your life where an investment property no longer suits your needs. After several years of depositing rent cheques, doing routine maintenance and upkeep on your property, and reaping stellar investment returns, you’re looking for an exit strategy to cash in your chips.
In most cases, the right time to sell a rental property will vary with your personal interests, financial circumstances, time limitations, your current and future aspirations, and your income needs. There isn’t a golden rule for when landlords should sell what’s likely their largest investment, but there are some key points to keep in mind when making the final decision. Here are five to consider.
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By running the numbers together accurately and identifying your future goals specifically, the right choice will become crystal clear
Recall what your overall goal was when you originally bought the property and ask yourself a few questions:
Do you like being a landlord or are you tired of midnight calls about leaky pipes and broken furnaces? Are you making money from the investment annually or is it a long-term investment that you project will be worth more when you sell? Do you have more demands on your time now, meaning the payoff isn’t worth the time required to manage your rental property? And what’s your annual and projected long-term rates of return on your investment.
Considering these questions thoughtfully will help guide your selling decision.
This can be difficult to project, but you can get a rough estimate by running a few back-of-the-napkin numbers. If you don’t expect to have significant changes in your lifestyle, you could use your current expenses for planning purposes. If not, ask yourself: What are your lifestyle goals? Do you want to travel? Do you want to spend several months in a warmer climate? If so, who is managing your rental property?
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You should also itemize your retirement income streams to find out if the income from the rental property is really needed. You may find that you have built up a large passive income stream in your other investment accounts, so you no longer require the income from the rental property to live comfortably. Pensions, registered retirement savings plans (RRSPs) and other investment account returns may be enough to cover your retirement lifestyle costs without having the responsibility of managing a property.
Alternatively, you may actually need the capital from the property to cover the costs of your chosen retirement lifestyle. With real estate prices at all-time highs, you may think now is an ideal time to cash in to enjoy the fruits of your labour. The final choice to sell will be a very personal one and is often tailored to the unique financial circumstances of the investment property owner.
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Tax on the sale of an investment property will come from the capital gain as well as the recapture. That gain is based on the selling price minus selling costs, which includes real estate commission, legal fees and other incidentals. You also need to subtract the adjusted cost base of the property (ACB), which includes any renovations or capital improvements (for example, a new roof or addition) that have increased the cost of the property for tax purposes.
Right now, 50 per cent of the capital gain is taxable and will be added to any other income you have in the year you sell your property. If you sell in a year when your income is lower, you may have less tax to be paid, and vice versa.
Real estate is often considered a separate asset class, or an alternative investment, but it should be considered in relation to other investment asset classes you hold. You may find that, going forward, you want to keep a smaller percentage of your portfolio in real estate. Keep in mind, too, that if all of your investments are in real estate, then all your eggs are in one investment basket. Returns could be very good when markets are going up, but they could become problematic if the market is declining.
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Even if you no longer want to be a landlord, you may still want to continue investing in the real estate sector. There are several ways to accomplish this without owning rental properties. For example, you could buy units of a real estate investment trust (REIT), a company that owns, operates or finances income-generating real estate. Modelled after mutual funds, REITs pool investor capital, making it possible for individual investors to earn dividends from real estate investments without having to buy, manage or finance any properties themselves — no sweat equity required.
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Other real estate investment possibilities include the TSX Real Estate Capped Index, real estate exchange-traded funds, or simply shares of publicly traded companies that invest in and manage real estate and infrastructure projects such as Brookfield Asset Management Inc.
A general rule of thumb is that no more than 10 per cent of your investment portfolio should be in alternative investments, but going as high as 40 per cent may be fine for someone who is comfortable with more risk.
But before making a final decision, discuss the idea with your spouse/partners as well as a good financial adviser and tax accountant. By running the numbers together accurately and identifying your future goals specifically, the right choice will become crystal clear.
Vickie Campbell is a certified financial planner and CIM in Ottawa. She can be reached at [email protected].
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