Before You Sell a Rental to Fund a Business, Run This Tax Worksheet

My wife and I sold a rental property and moved the money into index funds. I wrote about why in why I sold my rental property to buy index funds, and I still think it was the right call for us. But there’s a variation of that move that deserves its own post: selling a rental and using the money to start a business. Since I’ve also owned a vending business, that’s the example I’ll use.

I don’t think that’s a crazy idea. I do think most people run the numbers in the wrong order. They start with “what could this money earn?” and only later ask “how much of this money do I actually get?” Flip that. The tax bill comes first, and it’s bigger than most people expect.

Disclosure: I’m not a CPA or a financial advisor, and this is not tax or financial advice. There’s one affiliate link in this post; I may earn a commission if you use it, at no extra cost to you.

The mistake I see most: “I’ll just 1031 it”

A 1031 exchange lets you sell investment real estate and defer the tax by buying other investment real estate. A lot of people assume it covers any investment. It doesn’t. Since 2018, it only works for real property swapped for real property. Vending machines, ATMs, trucks, equipment of any kind: none of it qualifies.

So if your plan is rental in, vending machines out, you’re paying tax on the sale in the year you sell. There’s no way around that part, only ways to plan for it.

My worksheet, with an illustrative rental

Here’s the worksheet I’d fill in. The numbers below are made up, not mine, but they’re realistic. Swap in your own. I picked a property held ten years in a state with no income tax to keep it simple.

Step	Illustrative number
1. Original price (building portion $180,000)	$220,000
2. Depreciation claimed over 10 years ($180,000 / 27.5 x 10)	About $65,000
3. Adjusted basis (line 1 minus line 2)	$155,000
4. Sale price	$330,000
5. Selling costs, about 7% (agent, title, concessions)	$23,100
6. Net proceeds (line 4 minus line 5)	$306,900
7. Total gain (line 6 minus line 3)	$151,900
8. Tax on the depreciation part, up to 25% of $65,000	Up to $16,250
9. Tax on the rest ($86,900) at 15%	$13,035
10. Mortgage payoff	$140,000
Cash you actually get to invest	About $137,600

A few things to notice. Line 8 surprises people the most. Every year you owned the rental, you took a depreciation deduction. When you sell, the IRS takes some of that back, at your ordinary rate but capped at 25%. Line 9 could be 0%, 15% or 20% depending on your income. If your income is high enough (above $200,000 single or $250,000 married), add another 3.8% net investment income tax on the gain. And if you live in a state with an income tax, add that too.

In this example, the owner had $166,900 of equity and walks away with about $137,600. That’s the number I’d compare everything to. Not the sale price. Not the equity.

The question that decides it: what is the equity earning now?

This is the part that pushed us to sell. When I looked honestly at our own rental, the cash flow was small compared to the equity sitting in it, and repairs kept eating it.

So take your equity after tax and compare it to what the property actually nets you in a year, after every repair, vacancy and management fee. If your rental nets $4,000 a year on $137,000 of after-tax equity, that’s under 3%. A high-yield savings account might beat that, with no tenants. That doesn’t mean sell. Appreciation and loan paydown are part of the return too. But if the cash return is that low and a big repair is coming, the case for moving the money gets stronger.

The other side: if you have a mortgage rate from a few years ago that’s far below today’s, that cheap debt is quietly worth a lot. Selling gives it up forever.

Before selling, check the quieter options

• Borrow against it instead. A cash-out refinance or a home equity line isn’t a taxable event. You keep the property. The catch is more debt and a higher payment, which might wipe out whatever cash flow you had.
• Sell it with seller financing. An installment sale can spread the capital gain over the years you get paid (the depreciation part is generally still taxed up front). You’d get monthly payments from the buyer, which could fund machines slowly instead of all at once.
• If you once lived there, ask about the home-sale exclusion. If it was your main home for two of the last five years, up to $250,000 of gain ($500,000 for married couples) may be excluded. The depreciation from rental years still gets taxed, and rental years before you moved in can reduce the exclusion. This one matters to house hackers.
• Try the business before you bet the building. Buy one or two machines with savings and run them for six months. If you can’t find good locations with two machines, you won’t find them with twenty.

If you do sell, don’t swap one concentrated bet for another

A rental is a concentrated bet on one property in one neighborhood. A vending business is a concentrated bet on a handful of locations and your own effort. Trading one for the other doesn’t make you safer. It just moves the risk.

If it were me, I’d split the money. A real emergency fund first. A big chunk into broad index funds, because that’s where I’ve landed for most of our long-term money, and I explained that thinking in my reasoning for just buying index funds as a real estate investor. Then a measured amount into the business, added in stages as each machine proves itself. Tracking everything in one dashboard, like Empower, makes it easier to see whether the move actually improved your net worth or just changed how busy you are.

There’s an operator’s version of this, with a second worked example, the equipment depreciation question, and a table of when selling makes sense versus when it doesn’t: selling rental property to buy vending machines.

The three questions I’d answer before listing

1. What’s my after-tax number? Fill in the worksheet with your real depreciation and basis. Better yet, have a CPA do it before you call an agent, not in April.
2. Would I buy this property today, with this cash, at this price? If the answer is no, you’re holding it out of habit.
3. Have I proven the new plan on a small scale? One or two machines, six months, real numbers. If yes, the sale funds a business that works. If no, it funds an experiment.

Selling a rental to start a business can be a good move. We sold one for our own reasons, and the destination was different, but the arithmetic is the same. Just make sure you’re comparing the right numbers. The money you’ll really have is smaller than the money you think you have, and the plan has to work with the smaller number.