The tax implications of downsizing your home
There’s a tiny house movement going on but most people don’t have to go to the extreme of downsizing to 150 square feet to experience benefits from downsizing such as being able to pay off the mortgage quicker or putting away more towards retirement. People downsize their homes for a myriad of reasons. They might do so to discourage the kids from moving back in with them. They might choose to downsize in order to pay less for a mortgage, spend less time on maintenance and cleaning, have lower utility bills, reduce consumption on other items such as clothing, furniture or other consumer goods, or even to minimize stress. The negatives to downsizing aside from much less room, is that people downsizing are likely to have to give up items they may have emotional attachments to, there’s no room for guests and downsizing may require a lifestyle change. If you choose to downsize there will likely be tax implications.
If you’ve been living in your current home for decades, chances are that despite the Great Recession the value of your home has appreciated substantially. You can sell your primary residence at a gain and avoid capital gains tax for the first $250,000 or double that for married couples who file jointly. (You can do this multiple times but there must be two years between each sale.) However, for gains in excess of those amounts, you’ll have to pay a long-term capital gain on the difference. Most people won’t have the problem of unless they are in higher income brackets but for most homeowners, this is 15 percent but could be as low as 5 percent depending upon the seller’s taxable income.
In addition, gains that exceed the threshold may not be taxable on the whole amount since additions and other improvements increase the basis of your house and thus reducing your gain. Another way to handle gains on your home is to sell other securities that have losses or make charitable contributions to offset the gains. Individuals with serious health issues may benefit by renting out their homes until they pass in order to allow a step up in basis to eliminate any gain on the sale according to this article. If you are planning on purchasing a house, you may want to get a mortgage even if you could pay cash for the home because a mortgage might allow you to build your retirement fund.
Before you make any decisions about downsizing you may want to contact a local realtor that knows the market. You’ll probably also want to hire an elder law attorney and a financial advisor. The financial advisor can help put such a move into the greater context of your overall retirement account and the elder law attorney can help you make decisions on how to protect those assets should you experience an episode of uncovered long-term care.