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Am I “Tax Locked” In My Home?

As retirees age, it often becomes apparent that the home in which they raised families may not be the home they remain in long term.  It may be more square footage than needed, or may require more cost and time to maintain than originally anticipated.  This challenge is amplified for widows or widowers who may have to take on this burden alone.  But what happens when you determine that the home you purchased fifty years ago may trigger a huge capital gains tax if you were to sell it?

The Problem and Potential Solution

According to the Census Bureau, the median home value in New Jersey was $23,400 in 1970.  With decades of appreciation and the more near-term buying frenzy between 2020 and 2021, the average sale price of NJ homes in the first quarter of 2021 was $500,628 (according to data from New Jersey Realtors.)  That is an appreciation of over 2000%.  While retired homeowners may be looking at this as an opportunity to take advantage of, they also may be – correctly or incorrectly – looking at this as a problem with regard to taxes.

So if you are planning to downsize to a modest home that could accommodate future caregivers, or if you are planning on transitioning to a retirement community, it’s important to understand the capital gains exemption rules that were introduced in the Taxpayer Relief Act of 1997 and still apply today.  Assuming the home you are selling was your primary residence for at least two of the past five years, married couples filing jointly can exclude up to $500,000 of gain ($250,000 for single filers) on the home sale from your taxes.  You can also add to your cost basis any capital improvements you’ve made to your home on top of the purchase price.  So even if your home was bought decades ago for $50,000, you did a $100,000 renovation and as a married couple you are selling it for $650,000, it is likely you will have little to no capital gains tax to worry about!

Special Considerations for Second Properties and Widows

You need to be mindful of the ownership titling of your home to take advantage of this rule.  For instance, if you’ve gifted your primary residence to a trust or to your children, the exclusion on gain may not apply.  You’ll want to consult with your accountant or a real estate attorney to be sure.  The other caveat is that you can only take advantage of this strategy once every two years.  This prevents homeowners from claiming multiple primary residences in a short period of time to abuse the benefit.  Investment properties, such as a beach house or an apartment you may rent for income, would also not apply if it is not your primary residence.

What if we take the above example and apply it to a recently widowed retiree?  Would they be disadvantaged now that their exemption of only $250,000 applies?  Perhaps, but not as much as one may think.  If the home was owned jointly at the time of the first spouse’s death, the decedent’s ownership portion of that home would be “stepped up ” to the value at the date of death.  In our example above, let’s assume the home value at the first spouse’s death was $500,000.  The cost basis would be stepped up to $325,000 (if we took half the originally cost basis and added to half the value at the date of death.)  If the home was then sold by the surviving spouse for $650,000, the capital gains exposure would be $75,000 ($650,000 sale price – $325,000 cost basis – $250,000 exemption.)  This is why it is important to have an appraisal of the home and an estate tax return filed at the death of the first spouse.

Everyone’s tax situation is different, but retirees should not feel like a prisoner in their own home if there are concerns about taxes should they decide a move or if a downsize is appropriate.  It’s important to know the current rules and how they may apply to you.  Also, make sure you talk with your wealth advisor and accountant as some of these rules may change over time.

Important disclosure information

Please remember that different types of investments involve varying degrees of risk, including the loss of money invested. Past performance may not be indicative of future results. Therefore, it should not be assumed that future performance of any specific investment or investment strategy, including the investments or investment strategies recommended or undertaken by RegentAtlantic Capital, LLC (“RegentAtlantic”) will be profitable.

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This article is not a substitute for personalized advice from RegentAtlantic. This article is current only as of the date on which it was sent. The statements and opinions expressed are, however, subject to change without notice based on market and other conditions and may differ from opinions expressed in other businesses and activities of RegentAtlantic. Descriptions of RegentAtlantic’s process and strategies are based on general practice and we may make exceptions in specific cases.

RegentAtlantic does not provide legal or tax advice. Please consult with a legal and or tax professional of your choosing prior to implementing any of the strategies discussed in this article.

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