Magazine

Wealth Planning After Selling Your Home

By Cameron Rogers

Pop the champagne — you sold your home! Congratulations, this is huge.

It’s shaping up to be a really good year for sellers in general. Thanks to a number of factors, median home prices jumped considerably in the second quarter of 2021, up by more than 10% year over year across most of the country. It’s still a huge deal, though — so we wouldn’t blame you if you feel like tossing that tower of closing paperwork in the nearest dumpster. But selling a home means additional liquidity, which means there are just a few more things to plan for first.

Why is the real estate market so hot right now?

Low interest rates

When the pandemic started, the Federal Reserve — the central bank of the US, which regulates how much money is in circulation at any given time by adjusting the short-term interest rates at which other banks borrow money from each other — cut the federal funds rate from around 1% to 0%. That made it easier and more appealing to borrow, spend (like on a house), and invest. As a result, the average 30-year fixed mortgage rate banks offer their customers fell from around 3.3% in March 2020 to about 2.88% today. In a nutshell: the Fed dropping its interest rate has made it cheaper overall to buy a home right now.

The wealth effect

The wealth effect is often described as the outcome of generally positive financial markets, where many consumers take a cue to spend more (which stimulates the broader economy). Since the pandemic began, the number of millionaires in the world rose from just 5.2 million to more than 56 million, and the one percent increased their share of the world’s total wealth from 44% to 45%. Some reports suggest that this dynamic is why the real estate market, and the economy in general, are up right now.

Good ol' supply and demand

Believe it or not, despite factors like increasing residential vacancies, falling rents, and spikes in homelessness, the overall supply of homes for sale has fallen to historic lows across the country. The Fed says this could be due to a lot of reasons, from fewer sellers, to more buyers, to some combination of the two; the boom in remote work could also have pushed many to seek homeownership and many would-be sellers to hold onto their homes. Whatever the case, low supply means high demand — which is great news for sellers.

So what does a hot market mean for my post-closing plans?

While you may be tempted to toss the closing and settlement paperwork, you’re going to want to keep copies of everything right now. Also, keep written records of any and all improvements you’ve made to the home while you’ve owned it. These records are going to be extremely relevant come tax time.

When you file taxes for the year you sell your home, the IRS will need documentation for all the expenses and proceeds of the sale. Luckily, this also means you’ll be allowed to add improvement costs, closing expenses, and legal fees to your home’s cost basis for the years in which you still owned the property. And when your cost basis is higher, it may limit the capital gains tax you’ll be responsible for.

Wait, so any profit I make off the sale …

Yup — as with any asset, the sale of your home is also subject to both short-term and long-term capital gains rules. Short-term capital gains are taxed as ordinary income, with rates going as high as 37% for high-income earners. Long-term capital gains tax rates are 0%, 15%, or 20%, depending on your income and tax-filing status.

If the property you’re selling is your primary residence, any profit you see may be exempt from capital gains tax, up to a certain point — $250,000 if you’re single, and $500,000 if you’re married and filing jointly. But there are a few exceptions: If the home isn’t your principal residence, or if you lived there for less than two of the five years before the sale, you won’t be able to claim the exemption. You also can’t claim the exemption if the property was acquired through a 1031 exchange within five years, or if you’re subject to expatriate taxes. And finally, you can only benefit from this capital gains exclusion once every two years, so if you sold another home within the past two years and used the capital gains exemption for that sale, you’ll be expected to pay the full tax(es) on this one.

So how do I start planning for what’s next?

OK, so now you’ve dealt with the taxes part of this whole process. There are just two more things to think about: what to do with the proceeds from your sale, and where you’re going to live next.

What should I do with this money?

You likely sold your home with some sort of plan in mind. Now it’s time to follow through on it. Maybe you’re planning to use them to buy your next home. Or maybe you have a different financial goal altogether. If so, is that goal a short-term one or a long-term one? Your answer should help guide how you reinvest the money — in equities (stock), fixed income (bonds), or otherwise.

  • Long term (several years) —> equities (stocks). If you won’t need to access that money for at least a few years, we typically recommend weighing your investment portfolio more heavily toward stocks. When you invest in the stock market, you’re generally taking on more risk — but because you have some time to invest in the economics of a company or companies, your principal will have several years (ideally five or more*) to potentially benefit from the long-term growth historically associated with those companies’ earnings and cash flow.

  • Short term (a year or two): —> fixed income (bonds). On the other hand, say you plan to use the money on a down payment on a new home a year or two from now. In that case, we typically recommend investing with less risk — to try to preserve that money, and maybe earn a little interest along the way — with bonds.

  • I’m nervous about the real estate market being low on supply, and I’m not sure whether I should buy again. What are the tradeoffs?

    That depends on what your goals are. The choice isn’t as black and white as it may once have been — contrary to popular belief, sticking to renting could have quite a few benefits over homeownership. So you should ask yourself some questions:

    • How long do you plan to stay in the home? The closing costs of obtaining a mortgage can cost 2–5% of the home’s value, so if you’re only planning to live there for three to five years, it might make more sense to rent and invest that would-be down payment money instead.

    • Are you willing to pay for maintenance costs? As a previous homeowner, you know that, on top of a mortgage, homeowners insurance, and property taxes, you can expect to spend 1–2% of your home’s value on maintenance each year — and that doesn’t include any extra renovations you might want to make.

    • Would renting a similar home (even over the long term) actually make more sense than buying one? From a financial perspective, there are a few ways to figure this out, but the New York Times’ rent-vs-buy calculator is a solid choice. But it might also be a better fit for your lifestyle and goals — don’t be deterred by decades of outdated messaging that would tell you otherwise.

    • Celebrate (but with a plan)

      Selling your house has got to be a huge weight off your shoulders — so take a moment to revel in it! And afterward, don’t hesitate to reach out to the Ellevest Private Wealth team — we’d be happy to help you plan your next steps.


Disclosures

If your financial goal falls inside of the 2-5 year range, you might want to consider a more balanced mix of equities and fixed income.

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Cameron Rogers

Cameron joined Ellevest after 10 years at JP Morgan, where she advised both high net worth families and institutional investors on investing and wealth planning. Today, she’s a financial advisor on Ellevest’s Private Wealth Management team, working with clients to help them develop personalized, long-term investment portfolios that align with their goals and values.