We know that leaving a place you’ve called home for years — maybe decades — is never easy. But if you’ve been eyeing warmer weather or someplace closer to the grandkids, a downsizing move may be right for you.
According to Senior Living, about 51 percent of retirees (aged 50 or older) downsize to cut costs, pursue a simpler lifestyle, or for logistical reasons.
It’s also important to consider factors like housing market trends, estate planning, and the political environment. All of these may impact the tax benefits of downsizing.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more – straight to your e-mail.
Profit and prosper with the best of expert advice – straight to your e-mail.
What should people know before they downsize?
Downsizing can be challenging to say the least. You may need to say goodbye to friends, goodbye to your larger house (unless you gift it), and goodbye to an old way of life. Plus, before you move, you must consider insurance rates, potential fees, and closing costs of selling your home.
But downsizing is also an opportunity to let go of a lot of “stuff” accumulated over the years. In fact, letting go of unwanted things is one of three creative ways you can lower your retirement taxes through minimalism. But there are a plethora of other reasons to downsize, like potentially:
- Reducing your mortgage payment, taxes, and other costs associated with a larger home.
- Freeing up capital for other retirement goals (more on that later).
- Simplifying your lifestyle and maintenance responsibilities.
Did I mention there are tax payoffs that may offset the trouble as well?
But before we dive into some of those tax benefits, let’s look at a key consideration for many, including retirees, involving capital gains on home sales.
Capital gains tax when downsizing
Hypothetically, if you paid $100,000 for your long-owned primary residence and sold the house for $150,000, your capital gains tax (the tax on the profit from the sale) would be on about $50,000 in income (assuming no cost deductions like home improvements and real estate fees ).
However, that is often not the case. This is because the capital gains home sale tax exclusion excludes up to a certain amount of your home’s sale price.
The capital gains tax exclusion is:
- $500,000 for married filing jointly
- $250,000 for single filers
That means you can exclude up to the above amounts from your taxable income (assuming you meet all other eligibility requirements). For example, You must have owned the home and used it as your primary residence for at least two of the five years before the sale date.
However, data show some retirees with high home values have been reluctant to sell in recent years. This is because the capital gains tax exclusion is not inflation-adjusted, meaning more homeowners face the capital gains tax every year. Plus, home values are still rising. All that equates to the tax benefit eroding.
Capital gains can also affect taxes on your Social Security (SS) benefits. Up to 85% of your SS benefits can be taxed, depending on your income. So, if your income is higher, more of your Social Security could be subject to tax.
You’ll want to weigh the various tax considerations and applicable state capital gains taxes before deciding whether selling your home is right for you.
Strategies for successful downsizing
Let’s consider a few tax benefits that can come with downsizing.
1. Reinvest tax savings
If you downsize your home for a smaller one, you could reinvest those tax savings into a retirement nest egg. Alternatively, you may wish to repurpose the cash saved for other outlays. According to AARP, the top five underrated retiree expenses are:
- Healthcare
- Home maintenance and remodeling
- Home and car insurance
- Travel
- Transportation
So, if you’re nervous about future years’ healthcare expenses or home maintenance costs, you can invest your tax-free cost savings from downsizing into something like a high-yield savings account or stocks and bonds.
Not to mention, the National Association of Realtors reports that about one in three homebuyers pays in cash. This means that if you sell your home in 2025, you could get a faster closing process, and the sale is less likely to fall through — leaving you more time to invest in what matters most in your life.
2. Save on property tax, income taxes, and estate tax
Downsizing homeowners also potentially take advantage of lower property taxes by moving to:
Relocating to a different state may also save you hundreds per year. For example, Tennessee has a median tax bill of less than $1,400 (at least $600 lower than the national average) making the Volunteer State one of the ten most tax-friendly states for retirees.
Moving from a high-tax place to a low-tax place can also have several other benefits, like:
- Lowering monthly maintenance and utility cost bills
- Reducing the need for a car (saving on auto property tax and insurance)
- Potentially less tax on items like groceries and gas, if you live in one of the highest gas tax states or a state that still taxes groceries
- Savings on state inheritance and estate taxes. For instance, Oregon has an estate tax exemption of $1 million, which means you may need to pay state tax on anything above that amount.
But if a move is in your future, visit the state Department of Revenue website wherever you’re moving. You’ll want to know how the state taxes income, including Social Security, 401(k)s, and annuities, or you could end up with a potentially higher tax bill than where you are now.
(Image credit: Getty Images)
3. Leverage the lifetime gift tax exemption
If you’re not concerned with reinvesting wealth from a home sale, you may want to gift your house to a future heir. Gifting your property and purchasing a smaller, downsized home may come with the following benefits:
- Maintaining close ties to the place you raised your children but without the physical and financial upkeep.
- Potentially reducing estate taxes upon death, since the appreciation of your property is not subject to estate tax after gifting.
However, your recipient must be ready for a larger home’s maintenance costs and other challenges. Also, gifting a house during your lifetime means the recipient doesn’t receive a step-up in basis, which could result in higher capital gains taxes if they sell the property later.
If you are interested in gifting your home, here are a few other tax considerations to keep in mind:
- Taxpayers may gift “tax-free” up to the annual exemption amount to one person at a time. For 2025, this annual gift tax exclusion is $19,000 for single filers ($38,000 if married filing jointly).
- If you give more than $19,000 to an individual, you’ll file an informational Form 709. This filing tracks how much you have given over the annual exemption across your lifetime, but that doesn’t necessarily mean you owe any tax.
- You pay taxes on gifts exceeding the lifetime gift tax and estate exclusion. For 2025, the lifetime gift and estate limit is $13.99 million.
Any gifts given exceeding than the lifetime gift tax and estate exclusion are subject to taxes ranging from 18% to 40%.
Note: President Trump raised the gift tax and estate exclusion ceiling in his first term through the TCJA. Some speculate a possible extension of this provision in his second term, but for now, this is the last year you can take advantage of the higher gift tax exclusion.
So, if you’re going to downsize — 2025 might be the time to do so. Consult an estate and trust fund planner for your specific estate planning situation.
Downsizing in 2025: Will Trump reduce housing costs?
Some may wonder whether a new presidential administration will mean a better or worse housing market in 2025. While President Trump has signed several executive orders addressing housing challenges like inventory and rising prices, It’s far too soon to tell what if any impact those will have.
Also, it’s important to remember that several factors influence the real estate industry, like population growth, inflation, interest rates, consumer confidence, and public policy.
Some policies that could affect the housing market in 2025 include:
- Whether or not Trump follows his pledge to lift building regulations: If he does, the housing supply could improve.
- If Trump’s policies lower inflation, as he has pledged — borrowing costs could decrease.
- However, tariffs may impact your wallet and raise inflation (thus household costs).
- A possible extension of the Tax Cuts and Jobs Act (TCJA) could allow you to continue giving more to your family and future heirs.
Downsizing bottom line
While navigating potentially new tax laws may be challenging, downsizing in retirement can allow you more flexible lifestyle options. It may give you more time to reconnect with the people and hobbies you love.
You may enjoy financial savings, like lower monthly costs or freeing up funds to grow your retirement nest egg and potentially save on the cost of living.
Just remember: Keep track of any tax planning considerations while planning to move. Ensure you have all records documenting the tax basis of your house. Also, consider any tax laws in the area you are moving to and how they may differ from where you currently live.
