Factors to considerYour Financial SituationThe Local Real Estate MarketTaxesYour Long-Term GoalsYour Risk ToleranceQuick MathsDetermine Your EquityCalculate the Potential RentDetermine Your Monthly ExpensesCalculate the Capitalization RateDetermine the Tax ImplicationsExampleConclusion
The decision of whether to sell your house or rent it out can be a difficult one. On one hand, selling your house can provide a significant cash infusion, while renting it out can provide a steady source of income. Both options have their pros and cons, and choosing between them depends on several factors.
Factors to consider
In this blog, we will discuss these factors and provide a framework for making the decision that is right for you, taking into account the US laws and taxes.
Your Financial Situation
The first factor to consider is your financial situation. Selling your house can provide a large sum of cash that you can use to pay off debt, invest in other assets, or make a down payment on a new home. Renting out your house can provide a steady source of income, but you will need to manage the property and deal with any repairs or tenant issues that may arise.
The Local Real Estate Market
The second factor to consider is the local real estate market. If the market is strong and your house is likely to sell quickly and at a good price, selling may be the best option. On the other hand, if the market is weak or you are unlikely to get a good price for your house, renting it out may be a better option.
Taxes
The third factor to consider is taxes. If you sell your house, you may be subject to capital gains tax, which is a tax on the profit you make from the sale. However, there are some exceptions to this tax. For example, if you have lived in the house as your primary residence for at least two of the last five years, you may be able to exclude up to $250,000 of the profit from the sale (or up to $500,000 if you are married filing jointly).
If you decide to rent out your house, you will need to report the rental income on your tax return. However, you may be able to deduct certain expenses related to the rental, such as repairs, maintenance, and property management fees.
Your Long-Term Goals
The fourth factor to consider is your long-term goals. If you plan to move back into the house in the future, renting it out may be the best option. This way, you can continue to build equity in the property and have a place to live when you return. On the other hand, if you do not plan to return to the house and you need the cash from the sale to fund other goals, selling may be the better option.
Your Risk Tolerance
Finally, you need to consider your risk tolerance. Renting out a property comes with risks, such as damage to the property, late rent payments, and difficult tenants. If you are risk-averse, selling your house may be the better option.
Quick Maths
There are some quick maths that one can perform in order to understand what is more beneficial. Below are the list of those parameters that one should consider.
Determine Your Equity
The first step is to determine your equity in the property. To do this, subtract your outstanding mortgage balance from the current market value of your house. This will give you the amount of equity you have in the property.
Calculate the Potential Rent
Next, research the local rental market to determine how much you could rent your property for. This will give you an idea of the potential rental income you could receive each month.
Determine Your Monthly Expenses
You will need to calculate your monthly expenses if you decide to rent out your property. These may include mortgage payments, property taxes, insurance, repairs and maintenance, property management fees, and any other expenses related to the property. Subtract these expenses from the potential rental income to determine your monthly cash flow.
Calculate the Capitalization Rate
The capitalization rate is a measure of the potential return on your investment. To calculate it, divide the annual net operating income (the amount of rental income left over after all expenses are paid) by the property value. This will give you a percentage that you can compare to other potential investments.
Determine the Tax Implications
Finally, consider the tax implications of selling your house or renting it out. As mentioned earlier, selling your house may subject you to capital gains tax, while renting out your property will require you to report rental income on your tax return.
By performing these calculations, you can determine whether renting out your property will provide a positive cash flow and a good return on your investment. If the numbers do not work out in your favor, selling your property may be the better option.
Example
Here is an example to illustrate the quick math involved in deciding whether to sell your house or rent it out:
- Assume that your house is worth $500,000, and you have a remaining mortgage balance of $200,000. This means that you have $300,000 of equity in the property.
- You research the local rental market and find that you could rent out your property for $3,000 per month. You calculate your monthly expenses to be $2,000 per month, which includes your mortgage payment, property taxes, insurance, repairs and maintenance, and property management fees. This means that your monthly cash flow would be $1,000 per month ($3,000 rental income - $2,000 expenses).
- To calculate the capitalization rate, you first need to determine the annual net operating income. In this case, the annual net operating income would be $12,000 per year ($1,000 monthly cash flow x 12 months). To determine the capitalization rate, you divide the annual net operating income by the property value, which gives you a capitalization rate of 2.4% ($12,000 / $500,000).
- Next, you consider the tax implications. If you sell your house, you may be subject to capital gains tax on any profit you make from the sale. However, if you have lived in the house as your primary residence for at least two of the last five years, you may be able to exclude up to $250,000 of the profit from the sale (or up to $500,000 if you are married filing jointly). On the other hand, if you decide to rent out your property, you will need to report the rental income on your tax return.
Based on these calculations, you can determine whether renting out your property is a good financial decision. In this example, a capitalization rate of 2.4% may be considered low compared to other investment opportunities. If your goal is to generate passive income, renting out the property may be a viable option. However, if you are looking to make a significant profit, selling the property may be a better choice.
Conclusion
The decision of whether to sell your house or rent it out depends on several factors. You need to consider your financial situation, the local real estate market, taxes, your long-term goals, and your risk tolerance. By weighing these factors, you can make an informed decision that is right for you. If you are still unsure, you may want to consult with a financial advisor or real estate professional to help you make the best decision for your situation.
