Gabe Bodner, Gabe Bodner of The Bodner Team

Gabe Bodner

You might have heard the term “downsizing” when you move in retirement, but I like to use the term “right-sizing” instead. The reason for that is many people actually move to a similar size home in retirement or even a larger home in some cases. When you right-size, it is extremely important to evaluate your housing needs not just for today but for the long term as well. In addition to understanding your best options for aging, it is also extremely important to understand your potential tax implication when selling as well.

One of the most misunderstood and costly challenges of selling a home today is the potential capital gains taxes. There are capital gains taxes associated with selling any property, regardless if it is your primary residence, vacation home, or rental property. However, there are very specific tax codes that allow you fantastic tax benefits (under specific situations) when selling a primary residence or a rental property. Many people have heard of a 1031 exchange which allows you to defer capital gains taxes but that is only applicable when selling a rental property, but I am not going to get into that today. What I want to address today are the taxes associated with selling a primary residence and section 1031 of the IRS code does not apply to primary residences. The section of the IRS code related to selling a primary residence is section 121 which clearly outlines the capital gains tax rules for a primary residence. I believe these tax laws changed in the 1990s and many people who have been in their homes before this rule change might not be familiar with how capital gains are handled today.

Under the current capital gains tax laws, if you have lived in your home for two of the last five years, you get to exclude the first $250,000 of gain for a person and $500,000 for a married couple from any capital gains taxes. What that means is if you are a married couple and your home has appreciated more than $500,000, you will likely have to pay capital gains taxes when you sell your primary residence. Again, people get confused around a 1031 exchange and think that they can sell their home and defer or avoid capital gains taxes if they reinvest their proceeds in a new home but that is again not possible on a primary residence. 

Over the last few weeks, I have met with numerous clients who have owned their homes for more than 30 or 40 years in the Colorado front range. In many of these cases, these clients purchased their homes for under $100,000 and their current home values are close to or over $1 million. It seems like many homes were purchased for 60 thousand dollars in the 1960s and 70 thousand in the 1970s. So calculating your estimated capital gains taxes is a very important factor to consider when selling your home as these taxes can become quite costly. 

The math for calculating capital gains goes like this: take your home’s sales price (you can subtract certain selling costs) and then subtract your “cost basis” (your cost basis is your initial purchase price of the home plus the costs for any major capital improvements). This number is referred to as your capital gain.

To calculate your taxable capital gain, you would take your capital gain and subtract your primary residence exclusion ($250K for an individual and $500K for a married couple). This amount is called your taxable capital gain, and this is the amount you would need to pay long-term capital gains taxes on upon sale (assuming you again meet the primary residence rules under section 121). Your capital gains tax rate will vary based on your specific situation and you must discuss this with your tax advisor. 

Let’s now take an example to see how this all works. Let’s assume you are married, and you have lived in the home as your primary residence for the last 30 years. You purchased your home for $100K and you spent $100K on major capital improvements over the years. Your home is now worth $1 Million. 

You would take the $1 Million sales price and subtract your cost basis of $200K ($100K purchase price plus $100K in capital improvements). This gets you to an $800K capital gain. As a married couple, you would subtract $500K for your primary residence exclusion. This now gets you to a $300K taxable capital gain. If we assume a 25% capital gains tax rate, that means you would owe $75K in capital gains taxes upon sale. This of course is just an illustration, and you should consult a tax professional to calculate your specific tax liability. Only use this as a simple guide.

Selling your home could certainly be the best option in retirement regardless of the taxes. However, this is simply a factor that you might want to consider when evaluating your options. If nothing else, you should set this money aside for taxes when you do sell your home. If selling is not an option, you might want to consider a Home Equity Conversion Mortgage on your current home to access some of your equity free of any income taxes and age in place.

By Gabe Bodner is a retirement mortgage planner and licensed mortgage originator in Colorado. Gabe utilizes the latest research from the top researchers to assist his clients to live for today and
plan for tomorrow. To reach Gabe, call 720.600.4870, e-mail [email protected] or visit