Question: I am debating whether to sell my home or hold onto it as a rental property, do you have any advice?
Answer: Homes are spending more time on the market right now, especially condos, giving homeowners more time to ponder whether or not they should remain on the path to sell or whether they should flip to a rental. I’ll share some tips and advice for anyone in the fortunate position to decide between selling or renting their primary residence.
Start with the Capital Gains Tax Exemption
Spouses filing jointly are exempt from paying taxes on up to $500,000 in capital gains and individuals are exempt from $250,000 if your home has been your primary residence for at least two of five years prior to the sale. In simple terms, assuming you’ve lived in your home for at least two years, if you decide to rent it out for more than three years, you lose your capital gains tax exemption.
Capital gains are calculated by the amount you sell for less your original purchase price less any transaction costs and capital improvements during your ownership, and any depreciation recapture, if it was ever a rental. It is not based on your mortgage balance.
For those with significant capital gains, this exemption is worth a lot of money so in a rent vs sell decision, make sure that if you rent, you are renting for long enough to generate enough value to offset the lost tax benefit.
I generally do not recommend renting for two years and then selling before the three-year mark because there’s risk, cost, and effort involved in renting that usually is not worth two years of rental value.
Don’t Confuse a Capital Gains Exemption with a 1031 Exchange
People often confuse the capital gains tax exemptions with a 1031 exchange. The capital gains exemption is a full tax exemption, up to $250k/$500k, on the sale of a primary residence. A 1031 exchange is the deferal of taxes on the sale of an investment property, only if the proceeds of that sale are used towards the purchase of another “like-kind” investment property. A 1031 exchange does not apply to a sale or purchase involving a primary residence.
Questions to Ask Yourself
There are a series of questions and thought exercises I recommend when making a rent vs sell decision for your home, including:
- What will you do with the money? If you are using sale proceeds to buy a long-term primary residence or significantly improve your life (e.g. early retirement), selling tends to make overwhelming sense. If you are simply investing the money, the decision is primarily a comparison of different investment vehicles/assets.
- What does the rest of your investment portfolio look like? Will it benefit from the diversification of a real estate asset? Real estate assets are unique in that they can create income and value growth (appreciation) at once, sort of like a growth stock with good dividends, which is a unicorn in the investment world.
- Will you manage the property yourself or hire a property manager (expect to pay them 6-10% of the monthly rent)? If you live locally, self-management might work. If you are out of state/country, travel a lot, don’t have the time for management issues, etc then a Property Manager is worth it. “Boots on the ground” that you trust, near your investment property, is necessary.
- Consider the costs, financial and your time, that come with a real estate investment, but not with other investment assets (stocks): Updates like a new roof, HVAC, appliances, etc eat into your expected returns. How much are the occasional headaches of being a landlord worth? At some point your toilet will leak or water will enter the basement or you’ll have a demanding tenant. And most likely it’ll happen on the first day of your family beach vacation!
What is the value of the tax benefits from an investment property (review with your CPA)?
If you’d like to discuss buying, selling, investing, or renting, don’t hesitate to reach out to me at [email protected].
We have access to the most pre and off-market listings across the DMV of any brokerage and are happy to share what’s available with anyone who asks.
Below are some of our team’s pre/off-market listings, details and additional listings available by request:
- Ballston - 4BR/3.5BA/2,400sqft – Townhouse (2008) – N George Mason Dr Arlington VA 22203
- Lee Heights - 5BR/3.5BA/3,000 sqft – Detached (1953) – N Taylor St Arlington VA 22207
- Annandale VA - 4BR/3.5BA/3,000 sqft – Detached (1951) – Valleycrest Blvd Annandale VA 22003
- Capitol Hill (Washington DC) - 4BR/3.5BA/2,000 sqft – Rowhouse (1914) – South Carolina Ave SE Washington DC 20003
- Mclean VA - 5BR/4.5BA/3,700 sqft – Detached Single Family (2023) – Randolph Rd Mclean VA 22101
