**What to Consider for a Rental Property After It Fulfills Its Role**
For rental property owners, determining the next steps when these properties no longer align with financial or lifestyle objectives is essential. Options may involve continuing to lease, selling, engaging in a 1031 exchange, relocating back in, or, controversially, keeping the property unoccupied. This article examines these alternatives through the perspective of John, a rental property owner confronted with a major decision.
### John’s Rental Property and Financial Context
John possesses a rental property in San Francisco that will soon be vacant. He acquired it for $1.8 million, invested $200,000 in improvements, and assesses its current worth at approximately $2.6–$2.75 million. While the property carries no mortgage debt, John still faces around $30,000 each year in holding costs, including property taxes, insurance, and maintenance. Currently rented at $8,200 monthly, he is contemplating selling or leaving it unoccupied due to stress associated with tenant management.
### The Four Primary Choices for the Rental Property
#### 1) Re-rent the Property
John has the option to re-rent the property, yielding an annual income of $102,000. Nonetheless, this option carries the risk of tenants being present when he intends to sell or relocate back, complicating his schedule.
#### 2) Sell and Face Capital Gains Taxes
Since John has already claimed the $500,000 tax exclusion from a previous primary residence sale, selling now might result in around $500,000 in capital gains taxes. After expenses, he anticipates netting about $2.4–$2.5 million, but the substantial tax repercussions may cause him to hesitate.
#### 3) Sell Through a 1031 Exchange
Engaging in a 1031 exchange would permit John to defer capital gains taxes should he reinvest in another rental property. However, this would necessitate him remaining a landlord—a role he wishes to evade.
#### 4) Reside in the Property
By living in the property for two years, John could ultimately sell it tax-free under the primary residence exclusion. This route coincides with his plans to move to Virginia but requires relinquishing his current rental arrangement.
### The Allure of Leaving the Rental Vacant
With a strong net worth, John contemplates keeping the property vacant as a “silent asset.” While this is manageable, foregoing potential rental income raises questions about opportunity costs. John feels that the property will significantly appreciate in value, driven by the ongoing tech boom.
### How Wealthy Do You Need to Be to Safely Leave a Rental Vacant?
John’s circumstances underscore the financial considerations of owning a high-value property without cash flow. Here are factors for landlords thinking of leaving a property empty:
#### Yearly Carrying Costs vs. Net Worth
– With a $2 million net worth, $30,000 constitutes 1.5% of wealth; at $20 million, it drops to only 0.15%.
#### Carrying Costs vs. Passive Income
If annual passive income sufficiently covers carrying costs, leaving a property vacant becomes increasingly practical. A guideline suggests keeping this under 10% of passive income for comfort.
#### Opportunity Cost
The potential lost rental income must be weighed against net worth to understand the impact of maintaining a property unoccupied.
### Insights for Other Rental Property Investors
1. **Timing is Influenced by Taxes:** Understand the tax consequences that affect selling decisions.
2. **Prioritize Lifestyle Over IRR:** Balance personal stress with potential financial benefits.
3. **Value Simplicity:** Consider the trade-offs of maintaining a vacant property against mental clarity.
4. **1031 Exchanges Are Strong Yet Restrictive:** They are most suitable for those dedicated to real estate investing.
### Concluding Thoughts
John is faced with a challenging decision: paying significant taxes to sell or retaining a property without cash flow. If carrying costs and unearned rent represent a minor portion of net worth, the luxury of keeping property vacant for peace of mind might be practical. If expenses seem significant, renting, selling, or exchanging could be wiser options.
### Readers, What Would You Decide?
If you were in John’s position, would you opt to:
– Rent it out?
– Sell now?
– Move back in?
– Execute a 1031 exchange?
– Leave it vacant?
Recognizing individual financial situations and the trade-offs involved is vital for making informed decisions in rental property management.