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Your Home - What is the Future Plan?

Your Home - What is the Future Plan?

April 06, 2023

A home can provide a treasure of family memories, shelter, and a place to sleep each night. A home can also offer financial windfalls through capital appreciation and tax write-offs. But a danger lurking for some homeowners involves higher debt amounts, rising interest rates, loss of income, or the possibility of falling or stagnant home values.

A thorough financial plan should explore options regarding your future living situation. Normal planning views the interaction between income, assets, and goals as the main factors in achieving financial objectives. But a critical planning item should account for the possible disposition of your residence during your lifetime. Perhaps a goal would be to remain in your home for as long as possible. Or are you planning on downsizing your house space? Are you moving to where children or other family members are? What will you be able to afford? Are you planning to rent the home eventually?

Below are some of the choices that many people will face during retirement:

      *  Remain in your home

Remaining in your home is probably the most desirable situation for most people. After all, who wouldn’t prefer to live their remaining lives in an environment they know and feel comfortable with? However, some unexpected factors can prevent you from realistically expecting to remain in your current home, such as health condition, the lack of a partner or roommate who can help care for you,  lower income, or the desire to move to a smaller (or larger) house or move near family members who live elsewhere.

If you remain in your house at the time of your death, the property will receive a step-up basis¹ to the market value at the time of death of an individual or an individual’s spouse if married.
¹See “step-up basis” below

  •  Sale of your residence

The sale of your residence will qualify for a capital gain exclusion of $250,000 per person ($500,000 married filing jointly), provided the house was used as the primary residence for at least two of the previous five years. ²
 A capital gain can occur if the difference between the home’s adjusted sales price and the adjusted basis is positive. Please note that the gain is NOT the difference between the adjusted sales price and what you still owe for the property (mortgage), which determines the net proceeds from the sale, but not the capital gain. Capital gain taxes may be due if the gain exceeds the available exclusion. 
  Also, another common belief relates to the old Sec 121 rule, which allowed homeowners over 55 to exclude up to $125K of a capital gain on the sale of their principal residence. However, this law was replaced in 1997 with the current law of possibly excluding capital gains up to $250K per person regardless of age.
²See IRS publication 523: Sale of Home


Joel and Linda want to sell their California home and move to Arizona to be closer to their daughter’s family, including two grandchildren. They purchased their California home in 1990 for $200,000. Over the years, they have made several long-term improvements to their property totaling $120,000. The adjusted basis of the house is $320,000 ($200K + $120K). The net selling price of their California home is 1 million dollars. They have lived in their house for over 30 years and qualify for the capital gain exclusion (they lived in residence for two of the past five years). The capital gain is calculated as follows:


  • Converting your primary residence into a rental?

There are several factors to analyze before making this decision:

Capital Gain exclusion - Because of the two-out-of-five-year rule, it is possible to convert the home to a rental (or not use the property as your residence) and still qualify for the exclusion if the rental or non-use of the property does not surpass three years (then the two-out-of-five years would not be met). This is a huge consideration. A married couple could lose up to a $500K capital gain exclusion which could cost $125K to $165K in taxes (Federal capital gain rates of 15% to 20%³ plus CA rates of 10.30% to 12.30%).
 ³ May be subject to an additional 3.8 Medicare tax

Ted and Julie want to convert their residence to a rental while traveling and living “on the road” for a while. They have lived in their house for the past 20 years, and the home has appreciated greater than $500K. They begin renting in January 2023. If Ted and Julie do not move back in or sell the residence before January 2026, they will lose the opportunity to use the capital gain exclusion of $500K (lived in 2021 and 2022, did not live in 2023, 2024, 2025).

 Stream of Income - Rental income during retirement can be a steady source of income to help fund your expenses and goals. The current average rent in the Tri-Valley area for an average-size single-family home is approximately $4,000 to $4,500 per month ($48K to $54K per year). The average home value in the area is roughly $1.4 million. The pre-tax return is between 3% and 4% ($48K/$1.4m) before deductions are made for ordinary rental expenses, property management fees, interest payments on a loan, and taxes. However, depreciation is allowed on the home during the rental period, which can lower the tax on the rental income.

Rental income could equate to dividend and interest income from a stock and bond portfolio in a taxable account. The capital appreciation on the home could equate to tax-deferred growth in a qualified or taxable account; you don’t pay taxes on the appreciation until the property is sold or funds are withdrawn. ⁴ The appreciation in Tri-Valley median home values has increased over 380% since 2000⁵ (through December of 2022). The S&P 500 has increased 48% over the same period.  
Qualified accounts require minimum payments beginning at age 73. Homeowners may receive a $500K capital gain exclusion.  
Source: Compass Real Estate

 ** Past Performance is no guarantee of future results


 Ken and Cathy purchased their California house in 1975 and have lived there for almost 50 years. The home has stairs and other have health issues, such as large rooms and stairs, that make living in their home problematic. They plan to move to another city and downsize their living space, but they want to keep their paid-off house and convert it to a rental. The rent for similar properties is between $4,000 and $4,500 a month. They also want to pass the house on to their son, who wants to keep it in the family.

 A few things to consider here. First, they will knowingly forego the exclusion of capital gain since they don’t plan to sell the home within the next three years. Does the loss of qualifying for the capital gain exclusion outweigh the potential benefits of owning a rental?

  In addition, not selling your residence results in no cash proceeds to purchase a new home, and unless a second home is available, a new home will be purchased or rented. How will the new residence be paid for?

Step-Up Basis - A step-up in basis resets the cost basis of an inherited asset from its purchase (or prior inheritance) price to the asset's higher market value on the date of the owner's death. Since California is a community property state, the death of one spouse will cause the whole property to receive a step up instead of just half of the property (as in non-community property states).  


Alex and Wendy, who live in California, bought their house in 1988 for $200K. Alex passed away in 2022 when the house was worth $1.5 million. The home’s cost basis is increased, or “stepped up” to $1.5 million on the date of Alex’s death. Wendy could sell the property for $1.6 million a year later and have only a $100K capital gain (excluding would eliminate any tax liability).


  • Converting your rental into a primary residence?

You may want to convert your rental into your primary residence for various reasons, but most of the time, tax savings is the primary motivation.

Wouldn’t it be nice to accumulate significant growth on a rental for several years and be able to exclude $500K of capital gain simply by moving into the rental for two years? Unfortunately, it’s not that simple.
Living in the converted rental for two years will qualify you for capital gain exclusion, but the exclusion amount will likely be lower than the maximum available amounts. The tax law states that the exclusion equals the proportional time spent as a rental to the total time owned since January 1, 2009.


Robert and Joan purchased a rental in 2012 for $1 million; today, the rental is worth $2 million. They decided to convert the rental to a primary residence in 2023 and 2024 and plan to sell once they’ve reached the two-year requirement (end of 2024). The calculation gain exclusion of sale is calculated as follows:


Only one-sixth of the available exclusion was available to Robert and Joan. The exclusion would be higher if the qualified use (time as a primary residence) were longer.

There are many things to consider and analyze when planning effectively for your future. Receiving financial advice from a source that is trustworthy, objective, knowledgeable, and obligated to act in your best interests can immensely help you in your journey to reach financial goals for you and your family. Please review our website for more information on our planning and investment management services. If you have a question or want to schedule a no-charge consultation,please get in touch with us at your earliest convenience.


Anthony B. Carr, CPA, CFP­®