Downsizing Your Way to a Lower Tax Bill!

You’ve finally done it! The kids are out of the house, you’ve finally gotten your finances under control, and you’ve built up enough home equity to pay cash for a home in some parts of the country. Now what? If you’ve thought about relocating to a place with a lower cost of living to reduce your expenses, what happens to your tax bill when you move?

It depends on what you do with your existing home.

Sometimes, simply selling the property might be the best option. You can maximize the gain exclusion ($250,000 for singles, $500,000 for married filing jointly). This exclusion will save you up to $75,000 in tax. If your profit on the sale is higher than these limits, you’ll generally still enjoy capital gains tax rates of only 15% on the remaining gain.

But let me introduce you to another option – one with tax benefits and a possible income opportunity!

You can convert the property to a rental by selling it at fair market value, to a business entity, which you own. Doing this can create huge benefits! You still get the gain exclusion I mentioned above so it’s possible this could cover all your tax. Second, this might create an income source in your retirement years through the rental income.

If you need some of your equity to purchase another home for yourself, you can refinance the property to provide the cash you need for your new home. Depending on how much equity you take out, you still may make a profit each month if the rents exceed your costs of maintaining the property (mortgage, property taxes, and other expenses).

Another big benefit of this strategy is that now you will enjoy a benefit your personal residence never provided: you can depreciate your rental property! Depreciation is a deduction the tax code allows for deducting part of the purchase price (the fair market value sales price you sold the home for). This often leads to a paper loss, which in certain cases can be used to offset against your other income. What this means for you is a lower tax bill at the end of the year!

Keep in mind, you will still have the investment of your old home which will continue to appreciate over the years. And, you will have added a new investment to your portfolio in your new home.

So there you have it, you’ve got the best of both worlds! You’ve taken advantage of the home gain exclusion, you’ve created an income source in your retirement years, you’ve got a valuable tax deduction through depreciating your old home, and you’ve added to your real estate portfolio through the purchase of your new home.

How’s that for downsizing?


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