In our work with individuals, families, and business owners, questions about real estate come up frequently:
- Is it better to pay cash for a home or secure a mortgage?
- Should I add my child to the deed on my home since he or she will inherit at my death anyway?
- To buy a home that I plan to use when I retire, should I take out another mortgage now and make it a rental property until I move in, or is it better to wait?
Today, let’s look at a question that arises when an individual is interested in turning their current home into a rental property.
- Does it make more sense to keep my current house and rent it out or sell it, reinvest the sale proceeds in another house, and make that a rental property?
To answer that question, we look at whether including a rental property in your portfolio 1) moves you toward your financial goals and 2) maintains the balance of assets in your portfolio. If so, it may be better to sell a primary residence and buy another property to rent out for two reasons.
Reason 1: Cost Basis
Your cost basis in the sale of real estate is the amount you paid for it plus any improvements. If you continue to own a home and convert it to use as a rental property, your cost basis when you eventually do sell the home does not change. If, instead, you buy a new home today to function as a rental property, your cost basis in that property is what you pay today.
Reason 2: The 2 of 5 Rule
To qualify for an exemption on the first $250,000 of profit (for a single person, $500,00 if you file a joint return with your spouse) from the sale of a home, you must use the home as your principal residence for at least two of the five years prior to the date of the sale. Once you rent out your home, it is no longer your principal residence; meaning you may lose the $250,000 exemption when you eventually sell it.
Before making a financial decision of this magnitude, we can help you look at both the big picture—your financial objectives—as well as the details of the properties involved to help you make the decision that’s best for you financially and personally. Contact Todd Feldman at [email protected] to get started.