Renting vs. capital-gain tax break
You have advised readers to rent out their home at retirement for income and appreciation. But, if five years down the road they have to sell, they lose the five years. Wouldn't this be a loss rather than a gain?" B.H.
Let's look at an assumed example to check the trade-offs. Assume your house is worth $125,000 with a basis of $25,000. The full capital gain would be exempt from taxes if you sold immediately. The $125,000 invested at 10 percent would yield taxable income of $12,500 annually.
If you rented the house at $600 a month, gross income would total $7,200 out of which you would pay property taxes, insurance, and maintenance. The remaining income would be tax sheltered by the noncash depreciation expense. Further, you could expect the house to continue appreciating. Assuming an average 10 percent annual appreciation compounded, your house would sell after five years for $200,000 after selling expenses.If basis has been reduced to zero , all of the sales price would be subject to capital gain tax, but only 40 percent would be reportable as ordinary income.
Assuming you sold the house on an installment contract to keep marginal tax at or less than 25 percent, you would pay over the years a total of 25 percent of $80,000 or $20,000. Your net gain would be $180,000 compared with $125,000 less the difference in annual income over the five years. If that difference amounted to $4,000 after taxes annually (an estimate only, as the actuals would depend on maintenance expenses and actual taxes paid), you would be approximately $35,000 ahead ($180,000 less $125,000 plus $20,000). Every year you kept the property longer than five years would increase the benefit of holding and renting the house rather than selling and investing the cash.