Ask Liz Weston

Get smart with your money

selling a home

Q&A: Why selling a valuable home can cost more than you think

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Dear Liz: Why do you seem to discourage older people living in homes that have appreciated over the years from selling because of the tax consequence? Recently, someone complained they could not move out of their family home because they would owe $400,000 in taxes. Why don’t you show the math: If they owe $400,000, even at the maximum (20% capital gains), that means they received $2,000,000. So even after taxes, they net $1,600,000. People who are asking the question you answered today need to either recognize they are swimming in money after taxes, or that they incorrectly think their net profit is taxed 100%.

Answer: If you’re referring to the couple who wanted to use their home sale proceeds to give down payments to their children, your math is a bit wonky.

The couple said selling their paid-off home would generate more than $1 million in proceeds. Proceeds aren’t the same as taxable gains, and the tax bill depends on the home’s original cost, qualifying improvements, selling expenses and the $500,000 home-sale exclusion for eligible married couples.

Taxable home sale gains can have the same impact as Roth conversions, in that they can raise Medicare premiums, make more Social Security benefits taxable and push other income into higher tax brackets. Some taxpayers also face the 3.8% net investment income tax.

Furthermore, the couple weren’t complaining that they couldn’t sell their home — they wanted to. My response was to remind them that their generosity could have big financial consequences.

Your ultimate point is a good one, though. Taxes matter, but they should never be the only consideration in a major financial decision.

Q&A: Should you give your kids their inheritance early?

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Dear Liz: My wife and I are 68 and 69, respectively, have been retired for more than a decade, and enjoy a comfortable retirement income from my pension and her Social Security (I’ll take mine at 70). We have no mortgage and enjoy steady growth in our retirement savings, which we rarely touch.

Both of our children have good, steady jobs but may never own homes here in California owing to extraordinarily high prices. My wife and I own our home outright and could generate north of $1 million in proceeds from its sale. Our children will inherit all of our assets, including the home, when we die, but we’re wondering “why wait?” Why not help them purchase homes now by selling ours and splitting the proceeds between them for meaningful down payments? We’re happy to rent if it means they can enjoy the benefits of home ownership now rather than later when homes will surely be even more expensive. Good idea or bad idea?

Answer: This could be a lovely idea or a disaster, depending on your circumstances and what the future may hold. If you or your wife need long-term care in the future, for example, you may regret cashing out this valuable asset.

Renting carries risks, as well. You could face potentially rising costs each year even in areas with rent control.

Also consider that selling your house could generate a significant tax bill. Your gain is generally the sale price minus what you paid for the home, certain selling costs and the cost of qualifying improvements you’ve made over the years.

You and your wife can exclude up to $500,000 of the gain, but the remainder likely would be taxable. The federal capital gains tax rate is usually 15% but can be up to 20% for those with high incomes. California doesn’t have a separate capital gains rate so you’d face an income tax rate of up to 13.3%.

If your children inherit the house instead, its tax basis generally would be adjusted to its value at your death, eliminating capital gains taxes on appreciation during your ownership. Of course, that could mean they’d have to wait decades for their inheritance, which would defeat your expressed goal of helping them buy homes now.

You may not have to give up homeownership yourself to make it possible for your children. Downsizing could help you free up cash for significant gifts, for example. (Gifts of this size generally require filing gift-tax returns, although you likely wouldn’t owe gift tax. The federal lifetime estate and gift tax exemption is currently $15 million per person.)

A fiduciary financial advisor could help you determine how much you can safely afford to give away without jeopardizing your own future. A tax professional or estate-planning attorney can help you structure any gifts in a tax-efficient way.

Q&A: No cash-back offer on unused exemption

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Dear Liz: When selling a home and qualifying for the $500,000 exemption, but only needing to use $250,000 of it, what happens to the unused balance? An accountant told my friend she would get it in cash, which sounds incorrect to me.

Answer: You’re right — that’s not correct. It’s so incorrect, in fact, that your friend is probably an unreliable narrator. It’s hard to imagine an accountant being so out of touch with this basic tax provision as to offer that advice.

Each homeowner can exempt up to $250,000 of home sale profits provided they owned and lived in the house as their primary residence for at least two of the previous five years. That means a couple can exempt up to $500,000.

There’s no cash-back offer if someone uses less than the full exemption. On the other hand, the exemption potentially could be used every two years, so it’s not exactly a “use it or lose it” proposition, either.