This article was originally published on U.S. News by Kristin McFarland, Wealth Advisor at Darrow Wealth Management

Do you see your home as an investment, or as a living expense? There is no right or wrong answer, but clearly defining how you view your home can help you weigh major financial decisions.

For many Americans, their home is their single largest asset. So why do so few people calculate their true return on investment after selling? To some, the entire transaction is just a living expense or sunk cost, but if you view your residence as an investment, wouldn’t you want to know the ROI?

Here are some new ways homeowners can view the true return on investment. This is not intended to reflect each buyer’s specific situation, and will likely be most useful for investors who purchased a home with a goal of “trading up” in a few years. Although home ownership can provide significant tax benefits to many Americans, for simplicity, potential tax benefits have been excluded from this calculation.

Price appreciation does not equal ROI. The ROI on a home is most commonly viewed as price appreciation – how much you sold it for less how much you paid for it. Sometimes selling costs are taken into account, too. The issue with this approach is that it doesn’t include all of the expenses incurred while owning the home, buying the home and preparing to sell it.

Conceptually, it can be difficult to determine how to calculate the true ROI on a home – the dwelling itself is a hybrid personal use asset and investment asset. However, ignoring the real cost elements falsely inflates the return on owning real estate and can lead to homeowners to continue over-investing in a property.

True return on investment for homeowners. Your home is likely among your largest assets, so it makes sense to know how it performed. To calculate the ROI on your home, consider starting with the most conservative approach. You can always adjust afterward to better fit your personal situation.

Here’s an example of calculating true ROI on the sale of your primary residence:

  1. Add up your acquisition costs. These are the costs incurred when you bought the home – your down payment, attorney fees, closing costs and so on.
  2. Add up your total costs of ownership. Breaking it down into subcategories, calculate the total payments made to principal and interest, taxes and insurance, repairs and maintenance, plus other expenses, such as HOA dues or condo fees.
  3. Add up your selling costs. Selling costs can be quite significant. Real estate agent fees alone are typically around 5 percent of the sale price. There will be additional expenses in closing costs and even if the sale is exempt from federal capital gains tax, you may still need to pay state and local tax.
  4. Find out your loan payoff amount. If you’ve already sold your home, you have this number. If you’re just thinking about selling, you can calculate this using an online amortization schedule or call your bank.

Once you have all your numbers, it’s time to analyze.

Did you make money on the house? The most conservative approach calculates your total profit or loss from home ownership by including all costs incurred in acquiring, owning and selling the home. Your total profit or loss can also be expressed as a percentage of your original purchase price and annualized to represent an average yearly return or loss.

Sale price - Buying, owning, selling costs (Step 1-3) - Loan payoff amount (Step 4) = Total profit-(loss)

Another approach to determining the return on your investment is to calculate a more accurate net appreciation figure. When trying to answer the question, “Did I make money on the house?” this is likely the formula you’re looking for. Instead of just subtracting your purchase price from the sale price, consider the initial costs of acquiring the property and subsequent expenses of realizing the profit (or loss) through the sale.

The price appreciation only contains part of the story. The initial down payment on the property represents a return of capital, so it is important to subtract that from the price appreciation. Similarly, the out-of-pocket costs of buying and selling the property can be significant and shouldn’t be overlooked when determining profitability.

Sale price Purchase pricePurchase price appreciation Costs of acquisition (down payment, closing costs, etc)Costs of realization (upgrades for sale, commissions, etc)Net appreciation

Are you better off renting? If your home didn’t provide the return you expected, consider the alternative – renting. After all, you have to live somewhere! This is a much more speculative analysis, but it’s helpful to put the numbers in perspective by calculating the net added cost to rent versus buy.

To start, estimate how much you would have paid in rent during the time you owned the home. Then, look at how much your total costs of ownership (mortgage payment, buying and selling costs; everything) have exceeded your rental costs. Next, find the opportunity cost for your down payment. Assuming the cash would have stayed invested in the market instead of the home, what do you estimate the return to be? Subtract these three figures from your projected rental costs. Finally, add back in your total profit or loss from the first formula. If the resulting number is positive, it indicates that while you might not have “made money” on paper, you were likely still better off buying than renting.

Other factors impacting return. Owning a home provides a significant tax benefit for many Americans. Since the mortgage interest and real estate taxes are deductible, most taxpayers will be able to itemize their deductions where they wouldn’t have been able to otherwise. For simplicity, the tax benefits of owning a home weren’t included in this analysis.

You should also consider market conditions. Some homeowners can choose when to sell; others may not have as much flexibility. Market conditions at the time of sale are the biggest driver of your ROI; but also something you can’t fully control.

As you determine what calculation best represents your situation, keep in mind that not every home will have a positive true ROI – and this doesn’t mean the property wasn’t a good investment. Depending on a variety of factors, such as neighborhood, length of ownership, condition and market factors, the appreciation of the home after expenses likely isn’t enough to pay you for living there, but it may be able to significantly offset the cost of housing.

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