After 40 years of sitting in traffic and punching the clock, you will sit and punch no more. While your home was great for raising a family and earning a living, you’ve decided to relocate in retirement. But you might be asking yourself, should I sell or rent my house? This decision is complicated because there are investment, tax and non-financial considerations. We will address them in that order.
Is Your Home Considered a Good Investment?
Your home as you have used it during your working years, is just that, a home. You have to consider it as a home first, investment second. If you are considering renting out your home, that order reverses. I often speak with clients who argue that they should keep the home because the rent is sufficient to cover the mortgage cost, or that, because there is no mortgage, this is good “passive income.” These are not good ways to evaluate the quality of the investment. Below are a few rules of thumb:
The 1% rule. You should be able to get 1% of the current purchase price of a home in monthly rent. But what if there is no purchase price? You already own the home. I believe that if you are approaching this objectively, you have to ask yourself: Would you buy this home for the current value, as an investment?
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more - straight to your e-mail.
Profit and prosper with the best of expert advice - straight to your e-mail.
For example, if a home is worth $750,000, you should be able to get $7,500 per month in rent. You may be thinking, “No way!” And, if you live in a high cost-of-living area, you’re probably right. It’s unlikely you’ll get that much. Instead, in these markets, you are often betting on property appreciation.
Some would argue that, with the run-up in prices over the last several years, the 1% rule is now too high. I think of it in the same vein as the 4% rule for retirement distributions. In certain environments, it may be too high or too low, but it is a good rule of thumb to at least figure out if you’re in range of the target.
Cap rates. Cap rates are the real estate term for yield. You take your total income, less operating expenses, and divide that by the home value.
For example, say you have a $750,000 home with $6,000 per month in rent and $2,000 per month in expenses. Your cap rate is $48,000 divided by $750,000, or 6.4%. The total return of the investment is the yield plus any expected appreciation.
Liquidity. Liquidity has to be a consideration, because compared to stocks and bonds, real estate is much less liquid. In certain markets, like the spring of 2021, real estate is easy to sell. The market in 2023, not so much.
Tax Considerations for Selling and Rental Property Income
There are significant tax benefits of selling a primary residence. So long as you have lived in a home for two of the last five years, you are entitled to the 121 exclusion. This will allow you to exclude up to $250,000 of capital gains. If you’re a married couple living in the home, it’s $500,000.
If you are considering turning your home into a rental, it’s possible you’ll lose that exclusion if you rent the home out for more than five years.
If you convert your home into a rental property, you have to consider how income will be taxed. As a general rule, income from real estate is taxed as income rather than (often more favorable) capital gains.
However, there is preferential tax treatment in that most expenses of the property are deductible, and the home value can be depreciated over time. Rental income and expenses are shown on a Schedule E. While the form itself is not complicated, having a rental property will complicate your tax situation and may require hiring a CPA or an enrolled agent (EA).
Non-Financial: Rental Property Isn’t Really ‘Passive’ Income
Consider the infamous three T’s: trash, toilets and tenants. Without them, being a landlord would be a breeze. It would also come with no financial benefit. To deal with such challenges, you can hire a property manager — and if you move out of town, you probably should. But that will eat into those cap rates.
The biggest complaint we hear from our clients who own rental properties has nothing to do with their ROI; it’s that they are always on call. I’m guessing that’s not how you want to spend your golden years.
Lastly, what if it’s possible you’ll move back? This is a big argument in favor of hanging on to your home. Transaction costs are so high in the real estate world that you do not want to be in a situation where you don’t like your new location, choose to move back and have to purchase a new place.
I realize that there was no clear advice here on what to do. Rather, you now have a list of the big things you should consider.
I will end on this: Dabbling in the investment property business is dangerous. The real professionals do this for a living and can make a lot of money, typically because of the leverage (loans) involved. I recommend against dabbling.
-
Seven Steps Couples Should Take Before Blending Their FinancesGetting on the same page now can ensure you remain successful throughout your relationship.
-
Charitable Remainder Trust: The Stretch IRA AlternativeThe SECURE Act killed the stretch IRA, but a properly constructed charitable remainder trust can deliver similar benefits, with some caveats.
-
Charitable Remainder Trust: The Stretch IRA Alternative
The SECURE Act killed the stretch IRA, but a properly constructed charitable remainder trust can deliver similar benefits, with some caveats.
-
Three Ways to Take Control of Your Money During Financial Literacy MonthBudgeting, building an emergency fund and taking advantage of a multitude of workplace benefits can get you on track and keep you there.
-
How Did O.J. Simpson Avoid Paying the Brown and Goldman Families?And now that he’s died, will the families of Nicole Brown Simpson and Ron Goldman be able to collect on the 1997 civil judgment?
-
What Not to Do if an Employee or Loved One Is KidnappedBusinesses need to have a crisis plan in place so that everyone knows what to do and how to do it. Sometimes, calling the authorities isn’t recommended.
-
Why You Shouldn’t Let High Interest Rates Seduce YouWhile increased interest rates are improving the returns on high-yield savings accounts, that may not be an effective place to park your money for the long term.
-
Need to Build an Emergency Fund? Seven Steps to Get ThereHaving a safety net can mean peace of mind on top of being able to maintain your lifestyle if a financial emergency strikes.
-
Which Type of Life Insurance Is Right for You?Life insurance isn’t a one-size-fits-all option. Here are the differences between term life, whole life and indexed universal life insurance.
-
What Happens Financially When You Work One More Year?The impact of saving more, spending less later and benefiting from an extra year or more of compounding can be truly staggering.
