Retirement Home Downsizing: Avoid Tax, Budget Shock

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Special Report:Retirement Planning 2015

Y ou've decided to sell your home and downsize to a smaller abode. You figure that you can put the extra cash to work to help fund your retirement.

After all, your home is one of your biggest assets, if not the biggest. Its mortgage is all or mostly paid off, and your home's value is likely much higher than when you bought it years ago.

But retirement advisers warn not to make your move until you've done your homework. Doing so will no doubt have a big impact on your retirement planning .

Research everything from tax liabilities to moving expenses and all other costs associated with your new home, preferably with the help of a professional adviser such as a certified public accountant.

"A professional will squeeze out the emotion and help you make a better business decision," said Michael Eisenberg, a CPA and personal financial specialist at Miller, Ward & Co. in Los Angeles.

Cash flow analysis is crucial, he says. Calculate how much money is coming in and how much is going out in your current home and in your new home, wherever it is.

Health and Taxes

"If you're selling a home and downsizing, it doesn't mean the home you're moving into will be less expensive. It depends on where you go," said registered investment adviser Melody Juge, president of Life Income Management in North Carolina.

For tax issues, Juge advises hiring a CPA. The American Institute of CPAs ( is a good place to start if you don't use one or you don't have a referral, she says.

Tax ramifications of selling a home that has greatly appreciated should be one of your first considerations before relocating, Eisenberg says.

For a married couple who has lived in their home for two out of the last five years, the first $500,000 on the gain from the sale is not taxed. For an unmarried person, it's $250,000.

In computing the gain, homeowners are allowed to add the costs of major improvements made over the years to the original price.

Say a couple bought a home for $70,000 decades ago and spent $130,000 on major upgrades. Their tax basis is now $200,000. If that home happens to be in an area where home values have skyrocketed and it sells for $1 million, the couple's gain is $800,000. But since $500,000 of that amount is not taxed, their capital gain is $300,000.

What is their tax liability on that $300,000? "Normally the federal capital gain rate is 15% (for taxable incomes of $450,000 or less for married couples)," Eisenberg said.

If a couple's adjusted gross income exceeds $250,000, they're also liable for a 3.8% surcharge to help fund the Affordable Care Act. "Even if there is only a small gain on a sale that is taxable, they would still be hit by the 3.8% surcharge," Eisenberg said.

For those in a high tax bracket, the tax on their gain could come to as much as 24%, including the 3.8% surcharge, he says.

Health is another consideration for retirees when deciding to move, especially in later years and in states with community property laws, such as California. If a homeowner dies, the tax base for a spouse or other heir is "stepped up" to the market value at the time of his or her death, rather than the original purchase price, Eisenberg says.

"It could be a huge difference," he said. "An older senior citizen in ill health with a house facing a huge gain might want to think about whether to sell now or wait."

Juge advises her clients to make moving plans while they are still young enough to plan methodically and before "medical issues force their hand," usually in their 60s.

Another Mortgage?

Once you decide where to go and what to buy, another question is whether to pay all cash or take out a mortgage. If you pay cash, you forfeit a mortgage deduction. Someone in a high tax bracket may be better off having a deduction, whereas for a person in a lower tax bracket the deduction is not as valuable, Eisenberg notes.

One option, he says, is to take a mortgage on a portion of the purchase price and use the rest of the cash from your home sale to generate income . If you move to a place where real estate values are lower, you could end up with money left over, even if you pay all cash for the new one. You can invest the extra cash to produce income or use it on travel and entertainment.

If you move to a cheaper location after you sell your home and still feel that you don't have enough cash flow, then consider renting, Eisenberg says. That way, all of the proceeds from the sale "will be available to pay your bills."

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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