I recently met with a couple who have a significant amount of equity in their home. After reviewing their financial situation, they asked me...

“Does it make sense for us to own our home?” They wanted to know would they be better off selling their home now, rent a place to live, and invest the cash they would receive from the sale? What a great question!

First I don’t want to gloss over the lifestyle impact of owning or not owning your home. It is part of the American Dream. It gives someone certain freedoms to modify or improve their property. And it provides stability of not having to move should your landlord raise the rent or cancel your lease. But let’s look strictly at the financial benefits using this couple’s situation.

My clients live in Southern Marin and their home is worth approximately $1.8 million. They owe $1.1 million on their mortgage and bought their property for $1.1 million over 10 years ago. This is important for how the capital gains will be treated. The couple is in their mid 40s, each provide income to the household and plan to work to retiring at approximately 65. Therefore we will use a 20 year time frame to compare two scenarios: selling and renting versus continuing to own their current home.

If they sold the home now for $1.8 million, let’s assume that they spend a total of 5% in commissions and closing costs. Their net sales price would be $1.71 million. After paying off the mortgage of $1.1 million, they would have gross proceeds from the sale of $610,000. But they will owe long term capital gains on part of the profit they made. The profit is the net sales price less their purchase price of $1,100,000. Because this was their principal residence for two out of the past five years, they are allowed to exclude $500,000 of gain for tax purposes. Then their tax obligation is based on the net sales price less their purchase price, cost of improvements (if they made any), and the principal residence exclusion, or $110,000. The combined Federal and State long-term capital gains rate is about 25%, so they will have to pay $27,500 in taxes. (The long term capital gains rate is expected to increase.) The cash they will then have after the sale and paying taxes would be approximately $582,500.

Now we’re going to make some best guesses about how the next 20 years are going to play out. We’ll use 7% as the rate of return on their invested money. Based on this, their $582,500 would be worth about $2.2 million. But we need to account for the taxes on the increase in value of the invested money. We’ll use our 30% long-term capital gain rate. This means that after paying the tax, their $582,500 would have a net value of about $1.75 million.

Since their expected rent of $5,000 per month almost equals their current housing expenses (mortgage payment, taxes and insurance) including the deduction they have for calculating income taxes, we are not going to account for any cash flow differences between renting and owning.

If they continued to live in their home with their current financial structure but planned on selling in 20 years, what would this look like? Let’s make the following assumptions as well: the appreciation rate of their home will be 3% per year. This is conservative by historical standards and less than the national average, despite the recent downturn in real estate values over the past few years.

After 20 years, their home would be worth about $3.25 million. We’re also going to say that they only paid interest on their current mortgage and do not pay down the principal. If they sold at that time, and making the same assumptions about selling costs and taxes, they would net approximately $2.5 million.

Based on these assumptions, the better financial choice would be to not sell the home. This is, believe it or not, a relatively simplistic example and analysis. It does not account for things like an increase in the cost of renting, changes in the tax laws that could happen. What may appear to be a small difference in our assumptions, such as an appreciation rate of 2%, can have selling now be a better choice. It also does not look at other financing scenarios with either their current home or buying a different home. This gets even more complex when you account for investment risk, cash reserves, if their income is likely to increase or not, are they able to save for retirement, children’s education, and so forth.

At Opes, we have a proprietary software application called Opes Advantage that we developed. The software allows us to take all of these assumptions and variables into consideration and immediately see the impact on our clients financial futures 5, 10, 20 or more years out. Knowing how different scenarios will play out is a great way to get grounded in deciding what action you want to take.

Jeff Smith has been helping families in the Marin community for more than 17 years. As a trusted financial advisor and mortgage advisor, Jeff helps his clients make better financial decisions to improve the outcomes of the financial choices in life.