An earlier version of this article incorrectly stated how the outstanding mortgage balance affects the taxable gain from the sale.
Dear tax man,
We are planning to sell our home in Sammamish, Washington, which is worth approximately $1.4 million. We still have a $310,000 mortgage. We will use the proceeds to purchase a house in Orange County, California, to be closer to family and relatives.
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We bought it in 1996 for $230,000 and made a series of home improvements that cost $120,000. Between moving and buying a new home in California as seniors, you can help us navigate all the taxes we’ll face.
What tax incentives should we expect now that we are both over 65?
California dreams
Dear dreams,
This is an important step in your life and I hope you find a great place that is close to your loved ones. It’s also a big tax step for you – and for many seniors like you. There will be a “silver tsunami” as baby boomers, typically ages 59 to 77, downsize.
Let’s figure out your tax situation as you start packing your belongings:
Box 1: Federal Capital Gains Tax
Suppose you get €1.4 million for your house. According to Redfin, average sales prices in Sammamish’s housing market were $1.8 million in May, up more than 13% from a year ago.
The added value is your profit after deducting your cost basis. If it’s your primary home, some of the profits skip capital gains taxes. For single filers, the first $250,000 of earnings is free of capital gains and $500,000 for married couples.
Certain home improvements will increase your cost basis, according to the IRS. That includes upgrades to bedrooms, bathrooms, patios, garages, central air conditioning, furnaces, floors, fences, pools and more. Keep the receipts, in case the IRS wants proof.
What can’t be included are repairs and maintenance that will keep your home functioning but won’t make it more valuable to potential buyers. Painting doesn’t increase the cost basis, and neither do leak repairs, the IRS says. (But you can include the costs of selling your home.)
Assuming the IRS considers all of your $120,000 in improvements as increases to your original purchase price of $230,000, that’s a cost basis of $350,000. So let’s look at the numbers. If you can raise $1.4 million (thankfully) with a cost of $350,000, that’s just over $1 million in profit.
But there’s still $310,000 to pay off the remaining mortgage balance.
The outstanding mortgage has no bearing on the tax scenario, says Rob Seltzer, president of Seltzer Business Management in Los Angeles. There is still a taxable gain of just over $1 million, he said.
Since you’re a “we” and (presumably) married, you’re set to avoid capital gains on the first $500,000 of profits. The remaining $550,000 would be subject to capital gains tax, which could be 0%, 15% or 20% depending on the rest of your income.
It is more likely that this is the mid-range rate. The 15% rate is a wide range that covers many people. For a married couple filing jointly, the 15% rate applies this year to households with annual taxable income between $94,051 and $583,750.
Meanwhile, that remaining $310,000 mortgage reduces the net after-tax cash, Seltzer said.
With a 15% rate, after the give and take of the margins for the final price and costs, you’ll face about $82,500 in federal capital gains taxes, Seltzer said. The tax authorities always get a discount, but such an amount is a small price to pay for a nice return on your investment.
After some quick calculations, assuming a $1.4 million sale on this home purchased in 1996 will give you about a 5% return on your home’s value each year, noted Jennifer Baick, vice president of the financial planning group at Mercer Advisors.
Box 2: State taxes in Washington
Your state has a relatively new capital gains tax. But profits from home sales are exempt from this capital gains tax, according to the Washington Department of Revenue. There is also no state income tax in Washington. But state and local real estate taxes will apply.
Box 3: California Income Taxes
You are ready to make a nice profit from the sale of your home. But be prepared to pay a lot to find an address in Orange County. The median sales price for homes in the county was $1.2 million in May, which is an 18% increase year-over-year, according to Redfin.
Unlike Washington, the Golden State imposes income taxes. But the proceeds from your home sale in Washington state should not be subject to California income taxes, Seltzer said.
That is as long as you do not become California residents for you sell your house in Washington, he said. “It appears their stay would take effect upon the sale of the property,” he told MarketWatch in an email.
Box 4: California Tax Benefits
California is one of many states that does not tax Social Security income. At the federal level, monthly payments become taxable once a couple’s “joint income” exceeds $32,000 per year.
You asked about the potential tax breaks and incentives for California residents over 65. California does offer some tax breaks, such as the Senior Head of Household Credit, aimed at older residents with special circumstances and income limits.
At the local level, Orange County and other California counties have property tax programs for certain blind, disabled and elderly taxpayers. These programs defer payment of property taxes but generate a lien on the property that must eventually be repaid.
Requirements include at least 40% equity in the home and an annual income of less than $51,762, according to the California State Controller. It’s worth asking a California tax expert if there are any other benefits available to you.
But even if this seems like only a limited number of tax reduction opportunities, it’s still worth it. Your biggest opportunity is your chance to be close to family.
