Is Downsizing the Right Move for You?

Dear Carrie,

My husband and I are in our late 50s and starting to think seriously about our retirement. With the kids out of the house and home prices up, we’re talking about downsizing to a smaller, less expensive home. Can you help us sort out the financial benefits?

—A Reader

Dear Reader,

First, let me applaud you both for starting to plan your future. Even if you don't make a move for several years, it's great to start the decision-making process now.

There's no question that moving to a less expensive home can reap financial benefits, both in terms of a profit on the sale of your current home, as well as ongoing savings on monthly expenses. However, from deciding where you'll move next to weighing the emotional attachment that you and your kids may have to the family home, there's a lot to consider. Although only you and your husband can truly decide when and if you want to make such a big move, I suggest that you start by crunching some numbers.

Add up the total monthly cost of your current home

Start by calculating what you spend each month to live in your current home. Your mortgage may be the biggest expense, but don't stop there. Add in property taxes, homeowner's insurance and utilities. Remember costs for water and garbage collection. Now estimate what you spend yearly for upkeep, not only for the physical repairs, but also what you may pay to a gardener or housekeeper.

Think about your next move

A smaller home could mean considerable savings on a monthly basis, especially if you move to a less expensive community, so run several scenarios. Will you buy a smaller single family home or a condo? Would you consider renting? Plug in some rough numbers for each scenario, including possible property taxes, condo fees, upkeep, insurance, and so forth, to determine how much you could realistically lower your monthly expenses.

Calculate the profit on selling your current home

Housing has been rebounding in many parts of the country, but don't make assumptions. I suggest consulting with a local realtor who knows your market and can show you recent comparable sales in your area.

Realize, too, that if prices are up for your home, prices are probably up for any other home you might purchase unless you plan to move to a less costly area.

Don't forget that you might owe capital gains taxes

With an idea of what your house may sell for, you can pretty easily calculate possible capital gains taxes. And here's where you might be pleasantly surprised.

Under current law, if you sell your principal residence for a profit, up to $500,000 of capital gains is tax-free for a married couple filing a joint return ($250,000 for an individual). So you might have no capital gains tax bill at all.

Of course, there are a couple of stipulations: 

  1. You have to have owned the house for two years.
  2. You have to have lived in the house as your principal residence for two out of the past five years.

If you meet those two criteria, the next step is to calculate your cost basis. This is your purchase price plus associated fees for both the purchase and sale, such as settlement fees, closing costs, commissions, etc. Add to this the cost of capital improvements (not repairs) you've made—upgrades, additions, landscaping—that have increased the value of your property. (Hopefully, you've kept receipts!)

Now simply subtract your cost basis from your estimated sales price to determine if you have a gain. If your gain is less than $500,000, your sale is tax-free and you don't even have to report it on your tax return. Any amount over $500,000 would be subject to long- term capital gains taxes.

Talk to your advisor

Once you've looked at these specifics, I also suggest that you talk to your financial advisor who can put these facts and figures in the greater context of your overall retirement plan. And if you're fortunate enough to be anticipating a significant profit from the sale of your current home, you'll want to be very careful with how you manage it. Your advisor can help you invest in keeping with your retirement goals and timeframe.

Consider the emotional side

Beyond the numbers, I'd give serious thought to how comfortable you'll be in a smaller place and how this move might impact your family. There are often a lot of feelings attached to a family home. Be sure to bring those out in the open, so that when you do make a move, you'll be able to enjoy not only the potential financial benefits of your new home but also the pleasure you get from living in it every day.

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