When empty nester taxpayers sell the homestead
Tax Consequences of Selling Your Home in Your 50s or 60s
by Gary Foreman
Is Downsizing In Retirement Right for You?
Choosing the Right Retirement Community
Rent or Buy in Retirement?
You raised your family in this home, but now you're in your 50s or 60s and the kids have all moved out. It's time to downsize. But what are the tax consequences of selling your home when you're an empty nester?
To help us answer that question, we went to Jeff Haywood. Jeff has been helping businesses and individuals with financial planning since 2001 and currently hosts The CPA Superhero Site. Before that he was a financial analyst in the corporate world.
Q. What happens taxwise if you move to a smaller less expensive home or condominium?
A. For income taxes, it depends on if the taxpayer itemizes their deductions on Schedule A. If they do, then they would need to look at how much interest and real estate taxes they will be paying on the new home compared to what they are currently paying. So if they are taking out a loan to purchase the new home, they may have more deductions and reduce their taxable income. If they pay cash for the property, they may reduce their deductions and not be able to use Schedule A to itemize their deductions. In reality, this can be more significant the larger the loan amount. What needs to be considered is the effect of the change on their deductions, which is really only the amount of their itemized deductions in excess of their standard deduction.
The additional deduction from taxable income associated with owning a home is really not as great as many think or advertise because the IRS code is so generous now with the standard deduction. For example, in 2015, the standard deduction for a couple filing jointly is $12,600 and an additional $1,250 for each taxpayer who has reached 65 years of age during the tax year. So unless their itemized deductions are over $15,100 for a couple filing jointly who are both over 65 years of age, then this issue is not important at all. And if their interest and real estate taxes are just over $15,000, then this is only a factor to that extent. Also, if a taxpayer's income is less than their standard deduction and exemptions, it is possible they will owe no tax and may not even have to file a tax return.
In retirement, a couple may do well overall financially to have their home paid for even though their itemized deductions may be lower.
Q. Is there a way to roughly estimate how much tax will be due if you decide to rent instead of buying a new home?
A. Again it is the issue of itemized deductions versus the standard deduction. So the taxpayer would look at the reduction in itemized deductions over the amount of the standard deduction if any. So unless the taxpayer has a lot of "taxable income" and a lot of deductions, then this really is not an issue.
Q. Are there any ways to avoid creating a taxable event when you sell your home?
A. There typically is no federal income tax on the sale of a person's homestead if the profit is less than $500,000 for a couple filing jointly. The issue gets tricky when the home was rented out for a portion of the last five years.
Have you started preparing for retirement?
Our pre-retirement checklist will walk you through the steps you need to take.
Q. Are there any tax advantages to turning your home into a rental and selling it later?
A. In most cases, I would recommend that a taxpayer not even consider this option. They may want to consider the option if they think the property is really going to increase in value or if they can get significant rent in excess of their interest and depreciation. The issue here is the depreciation of the property and recognition of ordinary income on all the depreciation taken (or could have taken) when they sell the property. Unless it is a really exceptional situation, the cash flow is almost a wash or a loss because of the tax when the property is sold.
You see when they convert it to a rental, they can lose the $500,000 tax free gain on the property and they pay not the favorable capital gains rate but the higher ordinary income tax rates on all the depreciation taken over the years, which is recaptured when they sell the property. In most cases, this is a bad idea. One exception might be if they intend to keep the property for a very long time and they get good cash flow on it and can save to cover the tax when it is sold.
Q. Is there any way to pass ownership to heirs that minimizes tax consequences?
A. There are estate planning techniques that can be used to accomplish this.
However, unless a person's estate is worth over $5.43 million in 2015, for example, then there will be no estate tax. So this is not currently an issue for the average person. For the one percent, whose estates are this large, they should consult an attorney who is experienced in estate planning.
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.
Take the Next Step:
- What will your taxes be when you sell your rental properties? Let the CPA Superhero answer that.
- Learn how to have a (federal income) tax free retirement.
- Determine if debt could derail your retirement and what you can do about it now. Our checklist can help you. Afterall, one of the most important ingredients for a comfortable retirement is to be debt free when you retire.
- Subscribe to After 50 Finances. You've learned how to work smarter, not harder. This weekly newsletter is dedicated to people just like you. Subscribers get a FREE copy of our After 50 Finances Pre-Retirement Checklist, a list of everything you need to do to be ready for retirement.
Share your thoughts about this article with the editor.