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Your Home is a Poor Investment

All things equal, owning a home is cheaper than renting.

Of course, all things are not equal. The income property owner can deduct more than the homeowner. If these tax savings are passed to the tenant the renter has an advantage.

Offsetting the additional potential deductions an income property owner can claim is the tax on the capital gains. Income property owner face recapture of depreciation claimed in prior years and long-term capital gains on the rest. The homeowner’s property has no depreciation to recapture and under §121 of the Internal Revenue Code, up to $250,000 of gain is excluded per person if this is their primary residence for 2 of the past 5 years. (Assuming there was no business use of the home.)

The biggest issue with renting versus owning is comparing apples to apples. Too often I see people compare a 3,000 square foot home against an 850 square foot apartment in a complex. They are not the same.

There are instances where renting can be cheaper than owning, but those special situations are rare.

As much as I argue owning is cheaper than renting, the brutally cold fact remains, your home is a poor investment.

Owning your home is better financially than renting. Still, home ownership is a poor investment. Owning is the least of two evils since you do need a place to live.
Owning your home is better financially than renting. Still, home ownership is a poor investment. Owning is the least of two evils since you do need a place to live.

Primary Home Investment

Your home is a place to live. You might also own a vacation home or two. Regardless, you are not as diversified as you should be. You are generally locked into one geographic location.

Worse, many expenses are not deductible. A new roof is a serious out-of-pocket expense. If it is an improvement it may increase your basis. But since most taxpayers never exceed the §121 exempt income limits, few benefit from primary residence improvements.

Your home is not an investment no more than your car is an investment. Your home has a better chance of increasing in value, but the gains are very location specific and generally are in the neighborhood of the long-term inflation rate.

Home ownership does create an illusion. If you buy a $100,000 home with $3,000 down and inflation increases the value of your home over the next year to $103,000, you doubled your equity, without regard for any mortgage principle payments. Your $3,000 of equity in your home exploded to $6,000!

Unfortunately, this high rate of growth is anchored with greater risk. Foreclosure rates on real estate can be below .5% in a given year to over 2%. Yes, there are years (2009 and 2010 are the most recent) where more than 1 in 50 homes are in foreclosure! Couple this with the fact that over a third of homes have no mortgage and we can see high leverage in homeownership has risks that can easily destroy any value created.

Owning your home free and clear (no mortgage) reduces the risk of ownership. Property taxes, insurance and deferred maintenance can still strain the family budget. Insurance rates are causing serious stresses in certain markets. Florida is a prime example. Property taxes can also be an add financial strain. Then we have the surprise deferred maintenance costs. Even those without a mortgage can be put to the financial test.

Of course renting can mitigate some of these costs, as long as you are willing to trade down to a smaller apartment. Downsizing to a smaller home is also an option. But there are heavy costs involved when transferring real estate.

A massive advantage to home ownership is §121. However, homeowners face increasing costs with ownership. Property taxes, homeowner’s insurance, maintenance, energy costs, and other expenses related to home ownership has climbed 26% over the past four years, according to CNN Business. Homeownership costs have been climbing faster than the overall inflation rate, as of mid-2024.

That isn’t to say the cost of renting has not climbed at the same time. It is no surprise rent rates are climbing at the same rate as home ownership. The advantage the renter has over homeowners is that they can move to a new home easier than the homeowner due to the costs and time involved with selling and buying a home.

Home ownership, when compared between equal abodes, beats renting hands down. This one fact does not automatically make your primary residence a “good” investment. Yes, your home may appreciate in value and much of that gain is excluded from taxable income. Still, in the end, owning a home is an expense. Mortgage interest, insurance, property taxes, maintenance, the costs of buying and selling, and more make the final rate of return on your home among the worst investments you can make. But you do need a place to live.

The landlord turns a profit renting her property to you. This is why owning is better than renting. However, renters can reduce the rental cost by accepting a smaller home.
The landlord turns a profit renting her property to you. This is why owning is better than renting. However, renters can reduce the rental cost by accepting a smaller home.

Income Property Investments

If home ownership is such a terrible investment, how can anyone consider income property a good investment?

Buying a piece of real estate for income is a completely different animal from owner-occupied real estate.

First, the income property is purchased with a plan for turning a current profit. This is not even a consideration when buying a home to live in. (I know some people rent part of their primary home through Airbnb. That portion of the home, however, is income property.)

Second, and this is a big one, expenses match up much better with income. Owner-occupied property has a large disconnect between when expenses are paid and when income can be excluded under §121. Income property generally deducts expenses currently, or is depreciated.

Recent regulation changes affecting income property owners has provided additional tax benefits. §179 allows businesses to expense many assets the first year. Income property cannot use §179. But the §1.263(a)-1(f) de minimis election allows income property owners to deduct all asset purchases of $2,500 or less in the year of purchase. Stoves and refrigerators are now a deduction versus a depreciable expense over a number of year.

Even better, there are instances where an income property owner can deduct improvements of up to $10,000 each year! (The amount allowed under the §1.263(a)-3(h) election to treat improvements as repairs is limited to 2% of the unadjusted basis of the property or $10,000, whichever is less. That means a property purchased for $500,000 gets the full $10,000 benefit while a $300,000 property would be capped at $6,000. Any property over $500,000 in unadjusted basis enjoys up to $10,000 of improvements treated as repairs, when the election is made.)

Even though long-term capital gains taxes apply when selling an income property held for longer than one year, the long-term capital gains rate is lower than ordinary tax rates. Plus, when an income property is sold it is possible to defer gains using a 1031 exchange.

Finally, an income property owner can generate serious deductions currently using a cost segregation study.

When the advantages of a cost segregation study apply, an income property owner can accelerate depreciation by segregating out parts of the property with a shorter class life than 27.5 years (for residential property) or 39 years (for commercial property).

The property owner can even wait until an advantageous year to conduct the study and claim all the missed prior depreciation currently, even when no longer allowed to amend the return for the year of the property purchase. In short, this means an income property owner can buy a $1,200,000 property where $200,000 is for land and the rest for the building (improvements). A cost segregation study on the $1,000,000 of improvements can generate somewhere around $300,000 in deductions. (Passive activity rules apply.) The $300,000 can all be deducted in the current year.

When the income property owner waits until her tax liability is high, the cost segregation study allows a catch-up of all unclaimed depreciation to date the study would have allowed if done earlier. Form 3115 is filed to achieve this goal. This strategy maximizes the value of the study.

At the end of the day we need a place to live. Owning is better than renting. Still, owning your residence is a poor investment.

Income property owners enjoy an income stream the homeowner does not. While rental properties can be a good investment, it is because income property is very different from your personal home.

People get too hung up on real estate, in this accountant’s humble opinion. The right real estate, in the right place, at the right time, can be a good investment , as long as it throws off an income stream.

If mere home ownership was all it took for a “good” investment, more people would be rich. Home ownership does force savings, since the equity takes effort to tap. But mere home ownership is not a sure path to riches.

Your residence is an exercise in keeping costs under control. Still better than renting an equivalent property. Regardless, your home is a poor investment. Buy accordingly.


Thursday 20th of June 2024

When I hear forced savings, immediately social security comes to mind. With that being said, primary homes are 100% a poor investment and one where the majority of the middle class think their net worth comes from.

Keith Taxguy, EA

Thursday 20th of June 2024

Alonzo, Social Security is also a type of forced savings. The difference is you don't have a choice with Social Security. At least you decide to buy a home or not.

As for net worth, the middle class not only thinks much of their net worth is in their home, it actually is. Imagine the net worth the middle class would have if they made similar payments to their investment account with a serious rate of return? The middle class would disappear as it moved to a higher level.


Tuesday 18th of June 2024

I look at it as buying a home is a way of forced saving for people that would not ordinarily save

Dan Pinkston

Monday 17th of June 2024

Love this piece great advice. You nailed this one.