Downsizing Your Home: Don’t Overlook the Tax Impact

Downsizing is a smart move for many homeowners—it can reduce monthly expenses, cut down on maintenance, and even free up cash from a sale. But before you list your home, it’s important to understand how capital gains taxes may affect your bottom line.

The Capital Gains Exclusion

If you sell your primary residence for a profit, you may be able to exclude up to $250,000 (single) or $500,000 (married filing jointly) of those gains from taxes. To qualify, you must have:

  • Owned the home for at least two years.
  • Lived in it as your primary residence for two of the last five years.

There are exceptions for job relocations, divorce, or other unforeseen circumstances. Keep in mind—you can use this exclusion multiple times, but only once every two years.

Cost Basis Matters

Your taxable gain isn’t just the sale price minus your purchase price. You can add in certain closing costs and capital improvements (like remodels, a new roof, or landscaping), which raise your cost basis and reduce taxes owed. Routine repairs don’t count. However, depreciation (such as for a home office) or energy tax credits can lower your basis and increase your taxable gain.

A Real-Life Example

Jon and Jane purchased their home in 1990 for $250,000 and sold it decades later for $875,000. After factoring in improvements and fees, their cost basis was $297,500. That left them with a $522,500 gain. Thanks to the $500,000 exclusion, only $22,500 was taxable—resulting in a modest $3,375 tax bill.

Renting vs. Buying After Selling

Selling doesn’t always mean buying again. Renting can eliminate property taxes and upkeep while freeing up money for retirement. However, it also means giving up equity and facing landlord restrictions. The right choice depends on your lifestyle, financial goals, and future plans.

👉 Bottom Line: Downsizing can offer big financial benefits, but taxes play a major role in how much you actually keep. Keep detailed records of home improvements and consult a financial advisor before making your move.