Should you turn your current property into an investment while buying your next home?

A lot of homeowners are facing that decision, "Do I hang onto my current property, and turn it into an investment while buying my next home?"

Here's what you need to think about when you're making that decision. You have a home that has appreciated and you are purchasing a new home. You might be in a position where you can purchase without having to sell. That’s an awesome spot to be in, but is it the right thing? A lot of people will tend to want to do that because if they do that, they feel like, "Hey, I'm building a real estate portfolio."

The thing is, you also have to think about how long you're going to be committed to that home that you're holding onto, because you currently have a tax-free gain (or at least the first $500,000 if you're married, $250,000 if you're single) of appreciated value that is tax-free. If you were to move it from your current property that you've lived in for at least two out of the last five years to the new home that you're now purchasing, you now have this tax-free gain you can move over.

That down payment that has already been taxed, that you would have been purchasing the new home with had you held onto this one, well, those are dollars that have already been taxed. You can go ahead and purchase an investment property with those dollars instead. Again, think about if you're going to purchase a home and you own a home now, that's your primary residence, you're moving up to a different property and are you going to hold onto your current property as an investment?

What you're doing is effectively turning this tax-free gain into a taxable event in the future versus moving that tax-free money into the new home and using dollars that have already been taxed to purchase the investment home. A lot of the time the inclination is let me hold on to the current property and turn it into a rental. It's simple and it's convenient. What I'd urge you to do is really judge, is that the best possible rental property? Would you repurchase that home at today's value and turn it into a rental, or are you just simply doing it because you already own it?

That's really the ultimate test. You have to be willing to purchase that home had you not owned it because what you're effectively doing is, again, taking this tax-free gain and now turning it into taxable money down the line. Of course you do get to avoid closing costs, commissions and different things that'll happen during the sale by hanging onto this home. All that is well and good, but again, those closing costs might very well be a lot less than the tax that you're now going to face by turning that property that you own into an investment property. You're essentially giving up one of the greatest benefits of being a homeowner here in the state of California.