Stock Shocked? Your House Can Help

Lock in gains now from the hot real estate market

Herb Rubenstein and Laurie Bassi are in their late 40s and won't retire for years. The couple also has no interest in leaving the Washington (D.C.) area anytime soon. Yet Rubenstein, an attorney, and Bassi, an economist and investment consultant, rushed to sell the five-bedroom house in Chevy Chase, Md., where they raised two children as soon as their youngest graduated from high school in June. The house, which the couple bought nine years ago for $500,000, fetched around $850,000. "The hot real estate market had a lot to do with our decision," says Rubenstein.

So did a federal tax law, enacted in 1997, that lets married homeowners skip paying taxes on gains of up to $500,000 ($250,000 for singles) when they sell a primary residence. Homeowners can use that exemption as often as they like--as long as they live in a house for at least two of the most recent five years. Rubenstein and Bassi recently moved to a three-story rowhouse in Washington that they bought when they were first married but had rented out when they moved to the suburbs. Their long-term goal: to retire to San Diego or Boulder, Colo. They plan to invest the bulk of their home-sale profits in the stock market.

At a time when home prices continue to levitate while the stock market is leaden, investors are tapping real estate holdings in a variety of creative ways to help them bolster retirement savings. In some cases, they're empty-nesters such as Rubenstein and Bassi who are downsizing so they can reap plump, tax-free profits on the big family home. In other cases, they're people in their 30s and 40s who are taking advantage of low mortgage rates to buy a second home in a desirable vacation spot and renting it out until they retire.

Meanwhile, a popular strategy for the recently retired is to finance a home purchase even if they have cash on hand. The appeal: You can shave your tax bill with the mortgage-interest deduction while using your cash for living expenses. That way, you can delay withdrawing from tax-deferred retirement accounts when stock investments have plunged to their lowest levels in years. Of course, this plan works only if you believe future stock gains will outweigh mortgage costs.

Financial planners say one of the smartest things homeowners approaching retirement can do is to decamp to a smaller house or condo. "In today's red-hot real estate market, you shouldn't hesitate" to lock in profits before the bubble bursts, says Christopher Cordaro, a Chatham (N.J.) financial planner.

Cordaro urged a recently retired client and his wife, who are having a home built in Santa Fe, N.M., to sell their New Jersey house immediately rather than wait until the new house is completed several months from now. The couple plans to rent an apartment until the new home is ready. "It's risky to own two homes if your goal is to get down to one," Cordaro says. "If the market falls, you could have problems selling."

Another reason to trade down is that Uncle Sam allows you to keep more, if not all, of your profits. Before the 1997 tax-law change, homeowners, married or single, were allowed a one-time tax exemption of $125,000 from the sale of a main residence, and only if the homeowner (or one spouse) was at least 55. Homeowners of any age were also allowed to roll over profits from a home sale into a new house of equal or greater value as often as they liked. Five years ago, that tax-free rollover was eliminated and the repeatable $500,000 exemption came into play.

You needn't be an empty-nester to take advantage of the new rules. Michael Beriss, a financial adviser for American Express in Bethesda, Md., has a 45-year-old client who inherited a house when her mother died. Initially, the client planned on renting out her own home while she moved into her mother's house and renovated it for resale. But Beriss advised her to sell her existing home to obtain the tax-free profit, live in her mother's home for two years, and repeat the process.

One caveat: Your tax-free profit might be lower than you expected. That's because any profits earned before 1997 and rolled into subsequent home purchases must be added to your gain. Let's say you bought a house in 1996 for $500,000, paying for it in part by rolling over the $100,000 you earned on the home you sold. Today, your house is worth $1 million, so you'll earn $500,000 on the sale. But in the eyes of the Internal Revenue Service, your gain is $600,000, so you'll have to pay taxes on $100,000, says David Rhine. regional director of family wealth planning at Sagemark Consulting.

What if you want to expand your real estate holdings? Lou Stanasolovich, a financial planner in Pittsburgh, says a common strategy for homeowners who are buying a third residence is to finance the property with home-equity loans tied to their first two homes. The reason: You are only allowed to deduct mortgage interest on the first two properties you own. But you can write off the interest on home-equity loans of up to $100,000 on both residences, says Rhine.

Another way to tap your home equity is to refinance your mortgage. To qualify for tax-deductible interest, you can refinance up to the current amount of the mortgage, plus $100,000. However, your home loans can't exceed the property's value in order for the interest to be tax-deductible.

Home-equity loans can also provide the needed cash to help finance a retirement-home purchase--as long as you plan on moving within two to three years. Robert Reby, a Danbury (Conn.) financial planner, says a client and his wife are building a retirement home in South Carolina, but they don't want to move or sell their New York home for two more years. So instead of taking out a construction loan that can carry fees of several thousand dollars and require lots of paperwork, the couple got a home-equity loan. "It's a temporary, low-risk strategy," he says. The danger, of course, is that rates will rise--which means the variable-rate home-equity loan will become more costly. That's why Reby says this strategy is best when used to cover a relatively short period.

A popular strategy for people in their 30s and 40s is to buy a home in a desirable retirement community and rent it out. That's what Rayetta and Steve McCuiston, both 43, are doing. The Chicago couple bought a Sanibel Island (Fla.) condominium five years ago for $260,000 and sold it nearly two years later for $100,000 more than they paid for it. The McCuistons then upgraded to a $410,000 Gulf-front condo, which brings in about $33,000 a year in rental income. That covers nearly all of the carrying costs, Rayetta says.

Rayetta, a corporate trainer, says she believes her condominium will continue to increase in value because the verdant island strictly limits development. And with baby boomers set to retire en masse over the next two decades, Rayetta thinks she and her husband would have been priced out of the market if they had waited. "Our condo isn't our ultimate retirement home, but when we do retire to Sanibel Island, we'll sell it and use the proceeds to get the home we really want there," Rayetta says. In the meantime, the McCuistons use the condo for off-season vacations with their two teenage children.

For most people, their house is their biggest asset. With stocks sinking and bond yields low, it might also be their best tool for shoring up retirement plans.

By Susan Scherreik

    Before it's here, it's on the Bloomberg Terminal.