So you're asking the question- should I sell or rent out my house? You're planning on moving, maybe because you're upgrading to a bigger home, or relocating for a new job or to be closer to family. You own your current home, and you're trying to decide whether you should sell it or rent it out. You like the idea of growing your wealth through real estate, but not sure if you like the idea of being a landlord.
If you take nothing else away from this post, remember this: market conditions should be a factor in your real estate decisions, but not the driving factor. As in, being able to sell your home for a super high price point should be a factor in whether/ when you sell, but shouldn't be why you sell. Rising interest rates and property prices should be a factor in if/ when you buy, but shouldn't be the reason you choose to buy.
Should I sell?
Selling is most likely the easiest option. You close the chapter of owning that home, and move on to whatever the next chapter is. You'll walk away with proceeds you can use to buy your next home, pay off a large amount of debt, or use towards other financial goals.
The downside to selling is that it's somewhat of a permanent decision, in that you can't change your mind and get the house back. So you'll want to make sure you're thinking super clearly when you make this decision. (Maybe not right after going through a divorce, or losing a significant other!)
The other downside to selling is that if you decide you do want to become a landlord, it will likely be more expensive to purchase an investment property that doesn't start out as a residence. This is because non-residential home loans usually require a larger down payment, and charge higher interest rates. Also, as I write this, interest rates are going up, so new rates on any home purchase will likely be higher than your current rate, assuming you purchased or refinanced recently.
Should I keep my home as a rental?
Keeping your current residence as a rental when you move out may be the most affordable way to have an investment property. Your tenant will be paying down the principal on your loan, your house will *likely* grow in value over time, growing your net worth through capital appreciation. Ideally the rent income is enough to pay the mortgage, cover regular expenses, and save for property maintenance and repairs. If you have any leftover after that, you've got yourself a cash flowing investment. (For more info on cash flowing, ask a real estate agent for help calculating the "cap rate")
How could there possibly be a downside to easy passive income? I'm so glad you asked, and I would be happy to tell you. From personal experience, I've learned that being a landlord is EXPENSIVE!!! From broken pipes, to failing electric panels to dying appliances... it is not hard to end up spending more on a rental than you make. Not to mention the hassle of evaluating tenants, managing leases, and coordinating repairs, move-out's and move-in's. You can use a property management company, but that can take a sizable bite out of the income, and you'll still need to pay for repairs.
Aside from normal property risks, there's always a chance you could get a bad tenant. This could look like significant damage beyond their deposit that you get stuck with. It could also look like failure to pay rent, and even outside of a pandemic with an eviction moratorium, it is NOT fast or easy or cheap to evict a tenant. You'll need to be mindful of how many months you could cover if they stop paying.
And of course the obvious downside that not selling the home means you won't have that chunk as a down payment on a future purchase, resulting in a higher monthly payment.
What if I can't decide?
If you're on the fence, you still have options. Maybe you're 50/50 on being a landlord. Maybe you're moving out of the area, but not sure it'll be permanent, and thinking you may return. I have a strategy:
Keep your home, for now, go ahead and rent it out. Give yourself two years to see how it goes. At the two year mark, set a mental timer for one year- this is how long you have to make a decision before the stakes get higher. Why? See below from the IRS:
"If you have a capital gain from the sale of your main home, you may qualify to exclude up to $250,000 of that gain from your income, or up to $500,000 of that gain if you file a joint return with your spouse.You're eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale."
Sound confusing? Let me give an example. Let's say you bought your home for $250,000, and sell your home for $500,000. Your capital gain would be $250,000. If you sell your home less than three years after moving, this entire gain would be exempt from capital gains tax. If you sell it anytime after that three year mark, you have no longer lived in it for "two of the last five years" and are no longer eligible for the exemption. (Unless you move back in for two years, then sell. But that's a pain!)
Here's what that looks like:
$500,000 (Sale price)
-$250,000 (Original purchase price)
$250,000 (Capital gain)
If you miss the three year window and fall into the 15% capital gain tax rate, you'll owe $45,000 in capital gains tax!!! (Please keep in mind this is a very simplified equation, not including realtor fees, closing costs, or any state or local taxes you may incur- please talk to your accountant before making a decision!)
You can see why this three year window is important. Keep in mind, avoiding capital gains tax should not be the reason you sell versus renting, but it should be a factor in your decision making process.
If you're still unsure, here are some questions to ask yourself (and your partner if you have one):
- Can I afford to buy my next home with a mortgage I can afford without selling this home?
- Do I have the ability and capacity to handle minor repairs myself?
- Do I live close enough to the property to handle issues?
Can I afford to hire a professional to manage these issues and repairs?
- Am I wiling to take on the responsibility of being a landlord, or pay a management company?
- How many months could I afford to go with out payment from a tenant before compromising my own situation?
- Will I cash flow enough to cover unexpected expenses, or can I afford to cover that myself?
If you still need help, please reach out to a real estate agent or financial advisor for help making your decision.
Best of luck with your decision!
Your financially savvy friend/ LPL Financial Advisor,
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.