Is the value of your home a retirement asset?

August 1, 2005

The government... created a tax break for those who purchased a lower-cost residence for their retirement years.

A. In addition to the appreciation, your home has also provided you with substantial income tax benefits. Mortgage interest is generally deductible, as is your property tax payment. Depending on your long-term objectives relative to your home, you may be able to consider your home part of your overall investment portfolio. However, as a general rule, a home is not considered a retirement asset.

Even if your goal is to sell at retirement, you will probably buy another home to live in. The new home may carry a similar value to your current home; thus, you are simply exchanging homes, albeit possibly in a different part of the country. An alternative is to sell your home at retirement and buy a much less expensive home for your retirement years. In this case, the proceeds of the sale, minus the cost of the new home, could be added to your portfolio to generate additional retirement income.

The government recognized this dilemma and created a tax break for those who purchased a lower-cost residence for their retirement years. Tax law previously allowed an exclusion of up to $125,000 in primary residence gains if you were at least 55 years of age and had lived in the house for 3 of the previous 5 years. Additionally, this exclusion was only allowed once in a lifetime. Any gain on the sale of a home relative to the basis, which had been carried over from the sale of previous homes and on which the gain had been deferred, was taxable.

However, the rules changed with the Taxpayer Relief Act. This law as it relates to real estate sales now replaces the once-in-a-lifetime exclusion when "buying up" and the "age 55" rule. The Taxpayer Relief Act created a universal exclusion that benefits most homeowners and now provides an exclusion for gains of up to $250,000 to individuals filing singly. If a joint return is filed for the year of the sale, the exclusion applies to a maximum of $500,000 of gain.

To qualify for the exclusion, a taxpayer must have owned and used the property that is being sold as the principal residence for 2 years or more during the 5-year period ending on the date of the sale. For a married couple filing a joint return, one of the spouses must meet the ownership requirement, and both spouses must meet the use requirement of the residence to qualify for the maximum exclusion.

Q. I recently read an article about the benefits of using asset allocation for investment portfolios, but didn't really understand the underlying principles. Can you explain this concept in greater detail?

A. Asset allocation creates a balance for your portfolio by investing in a variety of asset classes, such as stocks, bonds, and money markets. Each component is designed to provide certain characteristics for your portfolio.

Stocks offer the potential to earn attractive returns, but they entail more risk than some other types of investments. Bonds are an integral part of asset allocation because they generally provide more stability than equities. By including both bonds and equities in your portfolio, you balance your portfolio.

Cash assets, such as money markets, offer liquidity and a convenient "parking place" for cash intended for future investment opportunities.