6 Financial Surprises That Can Complicate Downsizing in Retirement
Most downsizing advice stops at comparing what a home would sell for against what a smaller place would cost. Unfortunately, that comparison misses the calculations that actually determine whether downsizing helps or hurts.
The real downsizing math goes well beyond home prices, with taxes, healthcare costs, home equity and more all potentially changing the equation. Here are six things to consider as you plan to make the move to a smaller home.
Learn More: 4 Things You Might Regret Downsizing
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1. The Capital Gains Math That Most Long-Time Owners Skip
A home you’ve owned for 20 or 30 years may have gained a lot more value than you realize. While the tax break on the sale of a primary home is generous, it doesn’t necessarily make the entire gain tax-free. According to the IRS, a single filer can generally exclude up to $250,000 of gain, while a married couple filing jointly can generally exclude up to $500,000.
For example, if a couple bought their home decades ago for $150,000 and eventually sells it for $900,000, that's a $750,000 difference before taking into account things like major improvements and selling costs. If they qualify for the full $500,000 exclusion, they could still have some taxable gain left over.
2. The Carrying Cost Payback Period
According to Zillow, selling costs quite a bit of money upfront. Things like real estate commissions, closing costs and moving expenses typically add up to 8% to 10% of the sale price. To make sure your numbers are working for you, those upfront costs need to be measured against what downsizing actually saves.
3. The Medicaid Asset Conversion Problem
In many states, a person's home can receive special treatment when Medicaid determines eligibility for long-term care, while money sitting in a bank account may count toward the program's asset limits. The exact rules vary by state and by the person's circumstances, so it's important to consult Medicaid.gov for specific details.
This can make downsizing more complicated than you may initially expect. Selling a home can turn some of the value tied up in the house into cash or other financial assets that may be treated differently under Medicaid's rules. If someone is considering a move and expects they could need long-term care in the next few years, it's worth running the numbers with an elder-law attorney before putting the house on the market.
4. The One-Year Income Spike That Triggers Medicare Surcharges
A big capital gain from selling a home can create another surprise: higher Medicare premiums down the road. Medicare generally looks at your modified adjusted gross income from two years earlier when deciding whether you'll pay an income-related surcharge, known as IRMAA, on Part B and Part D, according to the official Medicare website.
A retiree who normally stays below the IRMAA threshold could suddenly find themselves paying more for Medicare because a home sale pushed their income higher for one year. The higher premiums generally apply for the following premium year, so the tax and Medicare effects of a home sale can stretch well beyond the closing date.
It's also worth noting that if your income later drops because of certain qualifying life-changing events, you may be able to ask Social Security to use more recent income information when determining IRMAA, per the Social Security Administration (SSA).
5. The Widowed Spouse's Basis Reset
When a surviving spouse sells a home after their partner dies, the tax bill may be smaller than they expect. In community property states, the home's tax basis generally resets to its fair market value at the date of death for both spouses' halves of the property, not just the deceased spouse's share, per the IRS.
This can reduce the taxable gain if the surviving spouse sells. In other states, the basis adjustment generally applies only to the portion inherited from the deceased spouse, though the exact rules depend on how the home was owned. Before assuming a home sale will come with a hefty capital gains tax bill, it's worth confirming which rules apply. The difference can be substantial.
6. The Imputed Rent Comparison
A paid-off home functions as a hidden form of income, as it eliminates a rent payment that would otherwise rise every year. Downsizing into a smaller paid-off home is often an excellent move. Selling and renting instead exposes a retiree to decades of rent increases.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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