Should you consider your principal residence an investment? This calls for a familiar answer – “it depends”. Some of us remember the 1970s and 1980s and hearing our friends and acquaintances tell us that their retirement fund was their principal residence.
While it was true that the value of our principal residence was steadily (and sometimes dramatically) increasing, so were the values of similar properties; and we have to live somewhere. If I sold my house for a 100% gain, I would have to purchase a house from someone else; someone who had also seen a 100% gain in the value of his/her house.
Any gain I have realized is just “funny money” that I will have to spend to purchase a similar residence. For most of one’s career, their principal residence is not an investment. Rather it is a home – a place to raise a family and to make memories.
This can, and often does, change as one nears retirement. If you are planning on relocating or downsizing after you retire, your house may indeed become a source of funds for your retirement. Statistics say that roughly 20% of retirees relocate, and we can assume that most of these relocations are to lower cost of living areas where home prices are lower.
Consider the retired fed who worked in Washington DC where housing prices are high, and who relocates to the Asheville, NC area where home prices are lower. This retiree may be able to sell their four bedroom colonial in suburban Maryland for $895,000 and get a nice three bedroom home near Ashville for $395,000.
If we assume that the Maryland house was paid off and the retiree paid cash for the North Carolina house, the capital gain was $500,000. Actually, after subtracting the costs of the sale, etc., the actual gain was less than $500,000.
The retiree in the above scenario both downsized and relocated and realized a capital gain of (say) $460,000. Using the common 4% “rule” for withdrawals, this would safely generate $18,400 of annual income ($1,533 per month) that could be increased annually for inflation.
How much in taxes did our intrepid retiree owe on this capital gain? Quite possibly none at all. The tax law allows a person who sells a house that has been their principal residence for at least two of the previous five years to exclude up to $500,000 from capital gain taxes if their filing status is married, filing jointly.
If one’s filing status is single, the exclusion is $250,000. There’s a special rule for those single filers whose spouse died and who sell the home within two years of their spouse’s death. As long as they haven’t remarried, they can claim the $500,000 exemption.
While you shouldn’t count on your principal residence to be a primary source of funding your retirement, it’s quite possible that you will reap some financial gain from its sale.
Don’t let the fact that you will see some gain from the sale of your principal residence when you retire dissuade you from socking as much money as you can into your Thrift Savings Plan and into outside Individual Retirement Arrangements.
After all, you rarely hear retirees complaining that they saved too much for retirement.