The decision to sell a highly appreciated asset is a tough one, especially in a market that is still moving higher as ours is today. Let’s talk strategy.
None of us likes the idea of leaving money on the table, and most of us are so averse to cashing out and paying Uncle Sam and Cousin Gavin that we leave our unrealized profits on the table and put them at greater risk every day.
So, to feel better about sitting on our hands we read the news each day and see that the US economy is still going pretty strong, the Fed is keeping interests pretty low and we don’t hear big-name economists predicting impending doom. Instead, we hear them hedge by peppering their commentary with terms like “headwinds” and “growing concerns” and “caution signs”. No one comes right out says the sky is going to fall by the end of the year. Truth is, they wouldn’t say that even if they believed it was true.
That leaves each of us alone to make our own decisions based on:
- What we know
- What we think we know
- What we know we don’t know and
- What we don’t know we don’t know
Number 4 in that play on words is the most dangerous because that where surprises come from. Surprises are nice when it comes to a birthday or an anniversary, but rarely good news when it comes to real estate.
A few weeks ago we wrote about the psychology of decision making, the process by which we “think our way into feeling good” about big decisions before we pull the trigger. We discussed the fact that we are always somewhere on a scale that is aggressive and bold on one end, wary and protective on the other and wait-and-see in between.
Where are you when it comes to the idea of selling your property and realizing a windfall profit even after you pay your taxes? Most of the property owners we talk to acknowledge the facts that prices are at all-time highs and the bull market is the longest in history. They also admit that they believe in market cycles and expect a market correction at some point.
If that is the case, why are so many property owners unwilling to go for the guaranteed win, sell their properties at record prices and otherwise redeploy their capital to cushion their risk of a market turnaround?
The biggest reason is taxes. There is no doubt about that. If a capital gains holiday through the end of the year was announced tomorrow morning, we would have another ten listings by the end of the day, as owners would scramble to get their properties on the market before the change in the supply/demand balance impacted pricing. We all know there will be no such holiday, but the point is made: taxes are the tail that wags the dog.
Another big reason for holding on to property is the perceived lack of investment alternatives. Everyone wants to maximize yield, own quality assets and minimize their risk. That’s what good investors do. But with prices so high, the benefits of exchanging are minimized, as every seller is going to insist on a premium price.
The exchanger might benefit from owning a different property, but his exposure to market correction is still very much in play, just as if he had done nothing at all.
This is the conundrum investors are in these days, and that’s because they are primarily driven by their aversion to being taxed. Yet, there are other options. Let’s take a look at one that few people even know about: the Installment Sale.
In an installment sale, the owner of the property converts his fee ownership in his property to an interest in a promissory note secured by a 1st Deed of Trust on the same property. The property is sold to a qualified buyer with an agreed-upon down payment and the balance of the purchase priced is financed by the seller at a market rate.
The seller exits the bull market at or near the top, gets a solid yield on his proceeds without the risks that go with owning the property, and he only pays capital gains taxes on the portion of his gain he receives in any given tax year. The buyer acquires the property without having to deal with a bank and pay all the fees associated with obtaining a mortgage.
Sound simple? Actually, it is, and it may or may not be the best option for you. More on installment sales coming your way soon…