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The Role of Your Home in Retirement

Price Trade-Down in Your Residence

Retirement is a time when you may decide that you want a smaller home. The children may have moved out and you don't need as much space as you used to. Also, you may want a smaller piece of property to maintain. Trading down your residence can be a source of cash.

Usually when you sell an asset you own at a gain, you have to pay your share of tax to Uncle Sam. But here's an important exception for homeowners. If you sell your principal residence and meet certain rules, you can exclude all or a portion of the gain.

If you sell your house at a loss, it is considered a personal loss and is not deductible.

Alternatively, if one of your reasons for trading down is to free up cash for other purposes, consider: Do you have substantial equity in your home? Equity is the difference between what your home is currently worth and what you still owe on it. If that number is considerable, then tapping into it via a home equity loan or line of credit may give you the cash you need while allowing you to stay put. Remember, when you sell and purchase a trade-down residence, a portion of that equity will be eaten up by closing costs.

How Do I Determine the Gain When I Sell My Home?

If you're going to sell your house, you should first determine how much of a gain, if any, you will realize. This is an important number, because at some time in the future, you may have to pay tax on this amount or a portion of it.

SUGGESTION: If you know that your profit on the sale of your home will not come close to exceeding the exclusion amount ($250,000 for singles and other taxpayers or $500,000 for married taxpayers filing a joint return), you don't need to calculate the basis of your home.

To Determine the Gain on the Sale of Your Home:

  1. First determine the adjusted basis of the house you've sold. To do so, take the original purchase price and add to it:
    • fees paid at the closing for title insurance, legal fees, surveys, broker's commissions, etc.
    • the cost of any capital improvements; these are costs that increased the value of your home and extended its useful life, such as adding a room, renovating a bathroom, planting new trees and shrubs in your yard, or putting in central air conditioning or a new deck. Costs which are considered repairs and maintenance can't be added to the cost of your home. These are expenses that keep a property in normal operating condition and don't add to its value or prolong its life. Examples are hiring a plumber to fix a leaky faucet, or repainting.
  2. Second, determine the adjusted sales price of the home:
    • the adjusted selling price is the amount you sold your home for, reduced by:
    • selling expenses—such as broker's commissions, state transfer taxes, attorney fees, etc.

Exclusion of Gain on the Sale of a Principal Residence

Homeowners may exclude up to $250,000 in gain from the sale of a principal residence ($500,000 for married taxpayers filing a joint return). The taxpayer must have owned and lived in the property as a principal residence for at least two of the five years ending on the date of the sale or exchange.

SUGGESTION: The exclusion is allowed each time a taxpayer who sells or exchanges a principal residence meets the eligibility requirements, but generally not more than once every two years.

Some other rules that may apply to your situation are as follows:

  • In order to get a $500,000 exclusion, a married couple must file a joint return; either spouse must meet the ownership requirement; both spouses must have lived in the home as a principal residence for two years; and neither spouse can have had a home sale in the preceding two years and excluded the gain from that sale.
  • Married couples filing a joint return who do not share a principal residence are each entitled to a $250,000 exclusion.
  • A single person who marries someone that has used the exclusion within two years prior to the marriage would also be allowed a $250,000 exclusion. Once those two years have passed since the last exclusion was used by either spouse, the full $500,000 exclusion would be allowed for a subsequent sale of a principal residence.

If a taxpayer fails to meet the two-year requirement due to a change in the place of employment, a change of health or other unforeseen circumstances, the taxpayer may be entitled to a pro-rata amount of the exclusion that would have been available had the ownership and use requirements been met.

Example:

Janet and Tom acquired their home in 2002 and sold it on March 1, 2020 for $500,000 (net of closing costs). They paid $200,000 for the home and put $58,000 worth of improvements into it. So their tax basis was $258,000.

Selling Price of Home Bought in 2002

$500,000

Adjusted Basis Of Home Sold

258,000

Gain

$242,000

Exclusion Amount

$500,000

Taxable Gain

$0

IMPORTANT NOTE: This special rule is only a federal exclusion. You may still owe state taxes. Consult with your tax professional as to the state tax consequences.

If you're going to sell your home, it may be a good time to call your tax professional for some advice.

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Member FINRA / SIPC. Osaic and Friend Bank are not affiliated. Products and services made available through Osaic are not insured by the FDIC or any other agency of the United States and are not deposits or obligations of nor guaranteed or insured by any bank or bank affiliate. These products are subject to investment risk, including the possible loss of value.


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