Q&A

Q&A: How to reduce capital gains taxes on a home sale

May 2, 2022 By Liz Weston

Dear Liz: We’re retired and living in California. We are planning on selling our home, which is paid for, and moving to Tennessee in a couple of years. I think we qualify for a “one time” capital gains exemption. Our home is worth over $1 million and we paid only $98,000 in 1978. We plan on buying a home in Tennessee for around $800,000. Will we have to pay capital gains tax?

Answer: Before 1997, a homeowner could defer paying taxes on home sale gains as long as they rolled the proceeds into the purchase of another home of equal or greater value. In addition, there was a one-time exclusion for homeowners over age 55, who could exclude up to $125,000 in home sale gains.

Those rules were replaced in 1997 with the current law. Now homeowners of any age can exclude up to $250,000 each in capital gains on the sale of their primary residence, as long as they’ve owned and lived in the house for at least two of the previous five years. As a married couple, you can exclude up to $500,000 of gain — but that still leaves you with more than $400,000 of potential capital gains.

The capital gains calculation doesn’t factor in the value of your replacement home or whether you have a mortgage. However, you can use the value of home improvements you’ve made over the years to reduce your taxable gain — assuming you kept those receipts. The IRS defines home improvements as expenses that add to the value of your home, prolong its useful life or adapt it to new uses. Examples would include additions (bedrooms, bathrooms, decks, garages, etc.), heating or air conditioning systems, plumbing upgrades, kitchen remodels and landscaping, among other costs.

Improvements don’t include maintenance required to keep your home in good condition, such as painting, fixing leaks or repairing broken hardware, or improvements that are later taken out. If you put wall-to-wall carpeting and then removed it to install hardwood floors, only the cost of the hardwood floors would count.

Many of the costs you incur to sell the home, such as real estate agent commissions and notary fees, also can be used to reduce the capital gain. You can find more details in IRS Publication 523, Selling Your Home. A big home sale gain can affect other areas of your finances, such as your Medicare premiums, and may require you to pay quarterly estimated taxes. Consider talking to a tax pro before the sale so you know what to expect.

Q&A: Executor duties

May 2, 2022 By Liz Weston

Dear Liz: My best friend made me her executor. She has no relatives. She has listed people to receive money, possessions and her house. She has left me money as well. Once everything is disbursed and bills paid, there will be leftover money. If she wants me to have it, what needs to be written in the trust?

Answer: Her will should include a phrase that disposes of her residuary estate. After listing specific bequests, she would include a phrase such as “the rest and residue of my estate goes to” followed by the name of the person she wants to have the remaining estate. This clause isn’t without its problems, however, since receiving the residuary estate could tempt you to stint the other beneficiaries. Keep in mind that as executor, you have a fiduciary duty to all the beneficiaries, which means you cannot put your own interests first.

Q&A: How to minimize taxes after you retire

April 25, 2022 By Liz Weston

Roth conversionsDear Liz: In preparing my 2021 tax returns, I was dismayed to find out that my first required minimum distributions from my retirement account have pushed me into the highest tax bracket ever in my life and caused 85% of my modest Social Security benefit to become taxable. Since I retired five years ago at full retirement age, I never had to pay taxes on my Social Security as it was the majority of my income. In my remaining years, I wonder if there is anything I can do to avoid paying about $8,000 to $9,000 a year in income taxes!? Even a partial conversion from a 401(k) to a Roth IRA would surely increase my Medicare Part B premium, another financial problem. I am not rich, just average middle class, and my financial goals are to carefully plan my necessary expenses so that I will not run out of funds. I do not need to leave an inheritance to my two adult children.

Answer: You’re probably correct that Roth conversions aren’t the answer now, although they may have been helpful earlier. You also may have been able to reduce the overall taxes you pay by waiting until age 70 to claim Social Security and taking distributions from your 401(k) instead.

You can discuss your situation with a tax pro to see if there are any other opportunities for reducing your taxes. Mostly, though, your situation is a good illustration of why it’s so important to get professional financial planning and tax advice well before you retire. Even if you think you’re well informed, you’re inexperienced — you’ve never retired before, whereas experienced financial planners and tax pros have guided many people through this phase of their lives.

Some of the decisions you make around retirement are irreversible and can have a profound effect on how much money you can spend. Ideally, you’d meet with a fee-only, fiduciary financial planner five to 10 years in advance of your retirement date and have several check-ins to make sure your financial plan is sound before you give notice.

Q&A: Switch to electronic documents

April 25, 2022 By Liz Weston

Dear Liz: I have to disagree with your suggestion to switch to electronic documents versus using the U.S. mail. People need to keep an eye on dubious actors like cable and cellphone companies, where it’s important to pay attention to sneaky new charges or “expiring discount rates.” The same is true for credit cards, where fraudulent charges are likely to appear. I know I will open and read a bill in the mail while email is much more likely to be deleted unread. It’s a personal preference, but I think it’s sound financial discipline. Also, good luck trying to refinance or get a loan using e-statements — lenders refuse them.

Answer: Your last statement may have been true for some lenders before the pandemic, but the financial industry was rapidly digitizing even before the lockdowns began. After all, uploading electronic documents is much faster and more secure than relying on the mail. Our last refinance was handled entirely electronically, although we did have to sign a few closing documents in person with a notary who sat six feet away on our porch. Even if our lender had asked for a paper copy of an electronic document, though, that wouldn’t have been a problem: That’s what printers are for.

If you’re in the habit of scrutinizing paper bills while ignoring your email, switching to electronic documents can be tricky. Some people use personal finance apps to help them monitor what’s happening in their accounts while others put reminders on their calendars to review their transactions.

Reminders also can help you avoid paying more when you take advantage of a limited-time offer, such as an introductory rate for a service or a teaser rate on a credit card. Put the expiration date on your calendar as a prompt to renegotiate with the company or find another deal.

Simplifying your finances also can help you more easily spot fraud and unnecessary charges. It’s easier to monitor one checking account, one savings account and one credit card than a bunch of accounts spread across multiple companies.

Of course, there will be some people who simply can’t change the habits of a lifetime. For those who can, though, electronic documents are the way to go.

Q&A: Leaving IRAs to charity

April 18, 2022 By Liz Weston

Dear Liz: In responding to the reader who asked how to plan around the tax consequences of leaving a traditional IRA to a family member, I wish you had mentioned the tax benefit of naming a charity as the beneficiary of a traditional IRA. There is no tax on the distribution of a traditional IRA to a charity. The consequence is that the income is never taxed (on the front end or back end) and a charity benefits from the IRA owner’s generosity.

Answer: The reader was primarily concerned with bequeathing assets to children and grandchildren after the Secure Act of 2019 did away with “stretch IRAs” for most non-spouse beneficiaries. One way to do that while also benefiting a charity is the charitable remainder trust that was mentioned in the column. These trusts require some expense to set up and aren’t a good option if the IRA owner isn’t charitably minded.

If someone’s primary goal is to benefit the charity, however, then qualified charitable distributions or outright bequests are certainly an option. Qualified charitable distributions, which can begin at age 70½, allow someone to donate required minimum distribution amounts directly to a charity; the distribution isn’t counted as taxable income to the donor.