Selling a rental house in Georgia: taxes, 1031 exchanges and the tenant

Most landlords who call us are not in trouble. They are tired. The tenant calls at night, the roof is getting old, and the house is worth a lot more than they paid for it. Before you sell, it helps to know what the sale will actually leave you with and what choices you have. Talk to your CPA before you sign anything. The tax side is where most of the money is.

What the tax bill on a rental sale is made of

Selling a rental is taxed differently from selling the house you live in. The exclusion that lets a homeowner keep much of their gain tax-free generally does not cover a house you have only rented out. The gain usually has three parts.

• Depreciation recapture. Every year you owned the rental, you could deduct depreciation. When you sell, the depreciation you took, or could have taken, is taxed back at a federal rate of up to 25%. This surprises many landlords, because it applies even if they never claimed the deduction.
• Capital gain. The rest of the profit over what you paid, plus improvements, is a capital gain. If you owned the house for more than a year it is taxed at the lower long-term rates.
• Georgia income tax. Georgia taxes capital gains as ordinary income at the state rate.

If you do not live in Georgia, expect the closing attorney to withhold part of the sale price for Georgia income tax unless an exemption applies. You settle up when you file your Georgia return.

Deferring the tax with a 1031 exchange

A 1031 exchange lets you sell an investment property and buy another one without paying tax on the gain now. The tax is deferred, not forgiven. It carries over into the replacement property. The rules are strict, and missing one usually cannot be fixed afterwards.

• Arrange it before you close. You need a qualified intermediary in place before the sale. The sale proceeds go to the intermediary, not to you. If the money reaches your hands, the exchange is over.
• 45 days to identify. Within 45 days of closing, you must identify the replacement property in writing, following the identification rules.
• 180 days to close. You must close on the replacement within 180 days of the sale, or by your tax return’s due date if that comes first. Neither deadline stretches for weekends or holidays.
• Like-kind. Real estate held for investment or business can be exchanged for other real estate held the same way. A rental house for a rental house qualifies, and so do many other combinations.
• Trade equal or up. To defer all of the tax, the replacement generally has to cost as much or more than what you sold, and you have to reinvest all of the cash. Any cash you keep, or any debt you do not replace, is taxed.

An exchange suits a landlord who wants to stay invested but change what they own: fewer houses, a newer house, or a property closer to home. It does not suit someone who wants to stop being a landlord and keep the cash. For them, the job is to know the tax bill in advance and plan for it.

Selling with the tenant in place

You do not have to empty the house to sell it. A sale does not end the lease. The buyer takes over as landlord on the same terms. Selling occupied often makes sense:

• The rent keeps coming in until closing.
• You avoid the vacant months, the make-ready and the turnover repairs.
• You never have to have the conversation about moving out.

The buyer pool for an occupied house is mostly other investors, so the price reflects the lease, the rent and the condition. Our guide to selling a house with a tenant in it covers notice periods, the security deposit and showings.

What to have ready

• The lease, the rent ledger and the security deposit amount
• A list of the repairs you know are needed, and of what you have replaced and when
• Your purchase closing statement and records of improvements, for your CPA’s cost basis
• Your depreciation schedules from past tax returns
• The contact for any property manager, and when their management agreement ends

Where we fit

We are landlords ourselves, and we keep the houses we buy. We buy rentals with tenants in place and will take over the lease as it stands. If you are planning a 1031 exchange, tell us early. We can schedule the closing around your intermediary and your 45-day clock.