It’s a seller’s market in much of the country. Real estate is a hot commodity, with properties in some areas being snatched up virtually as soon as they are listed.
That’s good news for sellers who can command a higher price for their homes. At closing, they may find themselves with extra money in their pocket. But finance experts say not to be too hasty in spending that cash.
Like any windfall, there is no one right way to spend the proceeds of a house sale. “It boils down to your priorities for the intended money,” says Keith Bernhardt, vice president of retirement and college products for Fidelity. To maximize it, you need to consider a couple of factors, including the taxes you might have to pay.
Popular options for home sale profits. Some people may be selling their current house in order to buy another. In that case, money from the sale may be needed as a down payment for the new home. However, not everyone is ready to make a purchase.
While home ownership is a worthy goal, some people would rather give up the keys and rent instead. “They want to lock the door and go on vacation,” says Steven Azoury, a chartered financial consultant and owner of Azoury Financial in Troy, Michigan, noting that the maintenance of a house can be a hassle.
For those not buying a new house, paying down high-interest debt is a logical way to use cash from a house sale. “That’s always the number one answer,” Azoury says. Buffing up retirement savings is also a good idea.
Other sellers are looking to do something a little more fun with their home sale proceeds. “We see a lot of people buying a vacation home or a second home,” says Theresa Williams-Barrett, vice president of consumer lending and loan administration at Affinity Federal Credit Union. “That seems to be a popular option.”
Buying a second home, going on vacation or splurging on a luxury is perfectly fine so long as it fits with a family’s priorities and finances, Bernhardt says. “Nothing wrong with that, but just do it in context of the big picture,” he says.
Consider your time horizon. Once you have an idea of how you’d like to spend the money, it’s time to consider how long it will be before you make that purchase. If you’ll be buying a new home immediately, a savings account may be the best place to keep money safe and liquid.
However, a bank account can be a poor place to keep money that isn’t going to be needed for a while. “It will lose value over time,” Bernhardt says. The minimal interest offered by savings accounts lags far behind the rate of inflation.
Azoury recommends that renters put their home sale money in a growth mutual fund. “Bonds aren’t paying anything,” he says. “Money markets are comical.”
Even if you have enough from a home sale to purchase a new house with cash, Azoury suggests only paying what’s needed for the down payment. The interest rates for mortgages are still low enough that it might make more sense to finance a house sale and invest the rest.
Don’t forget your taxes. Before you spend all the money, remember Uncle Sam may want his share. Gains from a house sale – that is, money above the purchase price and improvements made – can be subject to a federal capital gains tax. A married couple can exempt up to $500,000 of their gains from tax so long as they meet certain criteria such as using the home as their primary residence for two out of the previous five years.
States have their own criteria for exempting money from a house sale from tax. “There may be tax implications if you don’t purchase a home after a certain period or if you leave the state,” Williams-Barrett says.
However, laws vary significantly by state, and Williams-Barrett says her best advice for home sellers is to consult with a finance and tax professional. Foregoing this step could mean you end up spending your profits and then have nothing left over to pay a surprise tax bill in April.
Selling a home can be both an exciting and nerve-wracking process. When it’s done, don’t let the cash in your pocket slip through your fingers. Follow these guidelines and put that money to work furthering your family’s goals.