Dear Wealth Wise: We live in New England in a mortgage-free home. I’m 63, and my husband is 65. I collect Social Security Disability and a pension. My husband still works and owns a rental property in Arizona with a $75,000 mortgage at 3.9%. The house is worth $340,000.
Between my benefits, my pension, and our annuities, we hope to have enough retirement income to manage without the additional income from the house. But we are concerned that inflation will make that more difficult over time. We currently clear $700 a month after expenses on the rental, barring extra repairs.
My husband wants to retire at 68. In light of that, should we keep the rental or sell it? We’re worried about capital gains, real estate agent fees — and how those things might result in IRMAAs.
— “
Sign up for Kiplinger’s Free Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more – straight to your e-mail.
Profit and prosper with the best of expert advice – straight to your e-mail.
Dear “Landlord No More?”,
You’ll often hear that it’s wise to have diversified income streams in retirement. But what if one of those income streams comes with a world of risk and hassle?
In this situation, our reader asks a particularly savvy question. The couple wonders whether it pays to hang on to a rental property on the other side of the country. The rental income could clearly help with cash flow. But managing a rental isn’t easy, especially when you don’t live anywhere close by. And keeping a rental home means bearing the risk of property tax and home insurance rate increases, as well as ongoing maintenance and repairs.
Clearly, it’s a tough decision — especially since selling the home could trigger a large capital gains tax bill. There’s a capital gains exclusion of up to $250,000 per person for the sale of a primary residence. But because the couple is contemplating selling a rental property, that exclusion won’t apply. A jump in their income could also trigger an IRMAA surcharge on Medicare. And, of course, real estate agent fees will take a bit out of the sale proceeds.
Here’s how the experts suggest they approach this conundrum.
How well will your current income sources hold up over time?
The couple in this scenario has a few things going for them. Though they don’t mention retirement savings, they have a variety of guaranteed income streams. But that may not cut it in the long run.
“Hoping to have enough income in retirement is not a winning strategy,” says Nate Willardson, CFP and managing partner at Currents Wealth Strategies. “Before deciding whether to sell or keep the Arizona property, stress-test your income sources against different inflationary environments to understand what could happen to your purchasing power over time.”
As Willardson explains, Social Security benefits, including SSDI, are eligible for a cost-of-living adjustment each year. But pensions and annuities are often fixed, which means they can lose purchasing power over time. If you’re not confident in your future cash flow, says Willardson, then it may be worth holding onto the rental.
Andrew Wood, RICP and retirement planning advisor at Daniel A. White & Associates, agrees.
“I like the idea of keeping the Arizona house and using the income as an inflation hedge,” Wood says. “If prices and rents continue to rise, you would be able to use the income to help offset inflation and potentially raise the rent accordingly.”
Do you actually want to be a landlord?
Clearly, there’s a benefit to keeping the rental property despite the costs of ownership. But Cayden McLaughlin, CFP, EA, and financial planner at WealthAdvisor365, says that, in his view, this is also a quality-of-life question.
“Do you even want to be an out-of-state landlord in retirement? Is that really how you envisioned spending those years? Most people say no,” says McLaughlin. “An extra $700 a month probably isn’t worth the hassle of coordinating repairs from across the country every time something breaks.”
Willardson says that in his experience, most retirees prefer simplicity when it comes to their portfolios.
“Selling and reinvesting those assets for growth elsewhere is often the cleaner path,” he explains.
McLaughlin says that if you do sell the property, you can invest the proceeds in equities for longer-term growth. And you should still come away with a nice chunk of money, even after accounting for taxes and real estate agent fees.
“If they truly want income replacement, Treasury bonds may be worth considering,” McLaughlin adds.
Of course, there may be a compromise — keeping the rental but hiring a property manager.
“If you want to hold the property but shed the administrative burden, a local property manager costs roughly 8% to 10% of monthly rent and buys you real peace of mind from 2,000 miles away,” Willardson says.
That option would also lessen the risk that the couple might be unable to manage the property effectively as they age.
If you decide to sell, make sure to get your timing right
You’re right to be worried about a large capital gains tax bill on a home you have $265,000 worth of equity in. But if the burden of managing that rental property from afar is too great and you’re worried about future maintenance and repair costs, then selling could be the right choice.
In that case, Willardson says, “If you do sell, time it strategically. A lower-income year can reduce both capital gains exposure and the IRMAA impact on your Medicare premiums.”
Since your husband still works now, you may want to wait until he retires to unload that property, especially if you can do so before he claims Social Security. You may still face an IRMAA, as the house sale will likely bump up your taxable income in a single year. But you can mitigate the overall tax impact by waiting until your household income drops.
That said, don’t let the idea of an IRMAA drive you into a panic. Even if you do face that surcharge, it may only apply for one year, Wood explains. And from there, you can implement different strategies to minimize your taxable income. Municipal bonds, for example, are a good way to generate predictable income that’s always federally tax-exempt.
The decision: it depends
All told, you have two very strong options here. So there’s really no right or wrong answer.
“On its face, the rental property could be a solid source of supplemental income in retirement,” McLaughlin says. “The interest rate is low, there’s plenty of equity, and the husband is still working for a few more years, which can help pay down the remaining mortgage balance.”
But if you just don’t have the appetite to manage a rental property and bear the risk of rising ownership expenses, selling isn’t the wrong move. You might feel the sting initially in the form of a larger one-time tax bill and potential Medicare IRMAA. But from there, you might enjoy the peace of mind that comes with knowing you’re earning income more passively.
