For many retirees, their home is one of their largest financial assets. Whether you’re thinking about downsizing, moving closer to family, or relocating somewhere new, selling your home can free up a substantial amount of money. What many homeowners don’t realize is that the federal tax code includes special rules that determine how much of the profit from the home sale is subject to taxes. Understanding these rules before you sell can help you navigate the tax side of the transaction and potentially keep more of your hard-earned proceeds.
The home sale exclusion.
One of the biggest tax breaks available to homeowners is the Section 121 home sale exclusion. If you qualify, you can exclude up to $250,000 of capital gains from federal income tax if you’re single, or up to $500,000 if you’re married filing jointly. To qualify, you generally must have (1) owned the home for at least two of the five years before the sale, and (2) lived in the home as your primary residence for at least two of those five years. The two years don’t have to be consecutive, but they do need to fall within the five-year period.
For many retirees, this exclusion completely eliminates any taxable gain from the sale. However, if you’ve owned your home for several decades or live in an area where home values have appreciated significantly, your gain may exceed those limits.
If your gain is larger than the exclusion.
If your profit from the home sale is greater than the available exclusion, the remaining amount is generally taxed as a long-term capital gain rather than as ordinary income. Long-term capital gains are usually taxed at lower rates than wages or retirement account withdrawals.
In some cases, retirees may even qualify for the 0% long-term capital gains tax rate, depending on their taxable income for the year. This can make the timing of your home sale especially important. Selling during a year when your income is lower could reduce, or even eliminate, the federal tax on part of the gain above the exclusion. If your income is higher that year, any taxable gain is generally subject to the applicable long-term capital gains tax rate.
Don’t overlook your cost basis.
Many homeowners assume their cost basis is simply what they originally paid for the home. In reality it’s often much higher. Your basis generally includes the purchase price plus the cost of qualifying capital improvements made over the years, such as a new kitchen or bathroom renovation, an addition, a new roof, replacement windows, or a new HVAC system. These improvements increase your basis, which reduces your taxable gain when you sell.
These improvements can add up to tens of thousands of dollars or more, which is why it’s worth gathering old receipts and records if you still have them. If you don’t, your CPA may be able to help reconstruct some of those costs.
Other potential impacts of a home sale.
Selling your home can have tax consequences beyond the capital gains tax itself. A large taxable gain can also increase your overall income for the year, which may:
- Increase the portion of your Social Security benefits that are taxable.
- Trigger Medicare IRMAA surcharges, resulting in higher Part B and Part D premiums two years later.
- Affect your eligibility for certain tax deductions or credits that are based on income.
It’s very important to look at your entire tax picture before deciding when to sell. Coordinating the timing of the sale with other sources of income, such as IRA withdrawals, Roth conversions, or investment gains, may help reduce the overall tax impact.
Selling your home is one of the biggest financial decisions you’ll make in retirement. While the tax rules are favorable for many homeowners, careful planning can help you make the most of them. Before you list your home, meet with your financial advisor and CPA to estimate the tax impact, discuss the timing of the sale, and identify opportunities to keep more of your sale proceeds for the next chapter of retirement.
Frequently asked questions.
Do I have to buy another home to avoid paying taxes on the sale?
Under current law, you do not have to purchase another home to qualify for the home sale exclusion. As long as you meet the ownership and residency requirements, you may be able to exclude up to $250,000 of gain if you’re single or up to $500,000 if you’re married filing jointly, regardless of what you do with the proceeds.
What improvements can increase my home’s cost basis?
Generally, capital improvements that add value, extend the life of your home, or adapt it for new uses can increase your cost basis. Examples include kitchen or bathroom remodels, room additions, a new roof, replacement windows, HVAC systems, and major landscaping projects. Routine maintenance and repairs typically do not qualify.
Will selling my home affect my Medicare premiums?
If you home sale results in a large taxable capital gain, it may increase your modified adjusted gross income (MAGI) for that year. Higher income can trigger Medicare’s Income-Related Monthly Adjustment Amount (IRMAA), potentially increasing your Medicare Part B and Part D premiums two years after the sale. Planning the timing of your sale may help reduce this impact.
Can I qualify for the home sale exclusion if I haven’t lived in the home continuously?
The IRS generally requires that you have owned and used the home as your primary residence for at least two of the five years before the sale. Those two years do not have to be consecutive. There are also limited exceptions for certain circumstances, such as a job relocation, health issues, or other unforeseen events .
Disclaimer: The information above is for general educational purposes only and should not be considered financial, tax, or legal advice. Always consult with a qualified professional regarding your specific situation. You should consult with your CPA and/or attorney before implementing any estate planning, gifting, or tax-related strategy.