A financial dilemma familiar to many homeowners recently emerged for a Utah couple deciding whether to rent out their existing home or sell it. With a new build in progress, they’re contemplating strategies to maximize their equity. Financial commentator Clark Howard provided insightful guidance on this matter, emphasizing the potential financial benefits and drawbacks of each option. This situation underscores the complexity and importance of long-term financial planning for homeowners.
Historically, Howard has discussed the importance of calculating potential rental yields and tax implications before making such decisions. Consistent with his previous analyses, Howard stresses the need to weigh the pros and cons, especially considering current economic conditions and government policies on capital gains exclusions.
How Does the Current Rental Yield Compare?
The homeowners are weighing the financial strength of their current position. They own a home valued at approximately $560,000, with only $110,000 remaining on a 2.9% mortgage. Local rental market rates are around $2,800 per month for similar properties. Howard assessed these figures and made clear,
“You would want to be able to get rent more like $5,000 a month to justify tying up money in a property that’s worth now around $560,000.”
The rental yield at the current rate is less competitive when compared to other potential investment opportunities.
What Tax Benefits Are at Risk?
In addition to the rental yield issues, Howard pointed out a significant tax factor. Married couples can exclude up to $500,000 in capital gains if they sell their primary residence through a recognized exclusion window. He noted,
“The sale of that property would be completely tax-free for you. So 100% of that money would go to your pocket.”
Choosing to rent jeopardizes this benefit if the property is held too long as a rental.
The couple’s equity sits around $450,000, and converting their home fully to investment property status could negate the exclusion. Furthermore, as the property becomes a rental, the exclusion window starts to diminish, risking substantial tax costs if future sales don’t occur timely. Market trends, like the increase in CPI from 320.3 to 327.5, suggest potential for higher property values and tax responsibilities.
The mortgage rates for the new house, priced at $675,000, are higher at 4.99%. Selling and re-investing their equity could offset this increase by reducing the starting mortgage size. The current benchmark for 10-year Treasury yields aligns just below 4%, a standard indicator of mortgage rate trends.
Nevertheless, those in tight rental markets who find their properties yield significant rent compensating for expenses might consider alternatives. Howard’s guidance highlights the importance of individual financial calculations before major decisions.
Clark Howard’s measured advice encourages homeowners to analyze rental yields against carrying costs and to ensure capital gains benefits are secured. Calculating personal figures and evaluating market conditions are necessary steps for those facing similar choices, ensuring informed financial decisions that align with personal goals and market variables.
