by Gary Foreman

Are you an empty-nester looking to downsize? Be sure to first consider the tax consequences of selling your home if you’re over the age of 50.

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, for the 2023 tax year (when you file next year), the standard deduction for a couple filing jointly will be $27,700 and an additional $1,500 for each taxpayer who has reached 65 years of age during the tax year. So unless their itemized deductions are over $30,700 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 will be just over $30,700 or so, 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.

Related: Should I Pay Off My Mortgage Before I Retire?

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.

Related: Before Downsizing to the Rental Market for Retirement

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.

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.

Related: Emptied the Nest? Consider Taking in a Renter for Extra Cash

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, this is not currently an issue for the average person.

For the one percent whose estates are large enough to trigger estate taxes, they should consult an attorney who is experienced in estate planning.

Related Articles

• Is Downsizing In Retirement Right for You?
• Does Home Ownership or Renting Make More Sense In Retirement?
• 10 Ways Your House Can Make or Save You Money
• Comparing Retirement Housing Options: A Guide
• When Empty Nesters Move Out of the Family Home

Reviewed March 2023

About the Author

Gary Foreman is the former owner and editor of the After50Finances.com website and newsletters in 1996. He's the author of How to Conquer Debt No Matter How Much You Have and he's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com.