Thinking About Downsizing? Don’t Forget to Consider These Costs

Jan 13, 2022
Personal finance

If you’re an empty nester or just ready to reduce the time and effort involved in maintaining a larger home, you’ve probably thought about downsizing. With a smaller property, you could save money in reduced utility bills, property taxes, and insurance premiums. And you might be moving somewhere with a better climate! Here are four financial factors to include in your decision making:

1. Transaction Costs. When buying and selling a home, there are always transaction costs, ranging from closing costs to realtor commissions. Real estate commissions typically run 6% of the selling price, split between the buyer’s and seller’s agents. You might be pondering whether you could sell your home on your own, but it can involve a lot of work and may take longer without the benefit of a realtor’s expertise. If you use a buyer’s agent, you’ll need to pay a commission to them, but usually lower than 6%. Depending on the market, you may be able to negotiate lower commissions.

Both buyers and sellers can incur attorney’s fees and transfer or local taxes. Sellers typically pay for home inspection fees and possibly a homeowners’ warranty to incentivize potential buyers. Buyers may also incur title fees.

In this current hot real estate market, you may clear enough proceeds from the sale of your larger home to pay cash for your new home, but if you take out a mortgage, you’ll need to pay lender’s fees. These generally range between 1%-3% of the loan amount, with decreasing fees at higher mortgage levels.

2. Fix Up Costs. Before you sell your house, you’ll want it to look good to generate the best price. So, you’ll want to spend time and money on repairs and sprucing up the property. When you buy a new home, you might want new furnishings or appliances. Be sure to include these costs in your budget.

3. Moving Expenses. Moving costs vary depending upon the distance you move, the time of year, and the number of items. Local movers are paid by the hour, so you may want to do most of the packing on your own. Currently, hourly rates for each moving company employee are around $50 according to Forbes.com. So even a local move can cost a couple of thousand dollars, with long-distance moves many times that amount. Just like any large expense, get multiple quotes from reputable movers. Ask your realtor or acquaintances who’ve moved recently for recommendations, and don’t just rely on cost in your decision making process.

For long-distance moves, it’s likely the crew at your old home will probably differ from the crew at your new location. You’ll be expected to tip your movers at both ends, and it’s customary to buy lunch (and possibly dinner) for the moving crew.

4. Capital Gains Tax. Depending on the proceeds from selling your home and the length of time you owned that residence, you could incur capital gains taxes both on the federal and state level (assuming you live in a state that taxes income). On the federal side, if you’re a single taxpayer, you can exclude gains up to $250,000, and up to $500,000 if you’re married. There are two eligibility tests you need to pass in order to qualify for these income exclusions:

Ownership – You must have owned the property for at least two years during the five-year period ending on the sale date. Two years means periods aggregating 24 months or 730 days.

Use – You must have used the property as your principal residence for at least two years during the same five-year period.

You wouldn’t even have to own and live in the property at the same time. For example, you could rent a home as your principal residence for the first two years, and then buy it and rent it out to others for the next two. If you then sell the property in the fifth year, you’d pass both the ownership and use tests and qualify for the gain exclusion privilege. For married couples, at least one spouse must pass the ownership test and both spouses must pass the use test.

Also, you can only exclude the gain if it’s been at least two years since you utilized it. For married couples, that means neither spouse could have excluded a gain within that two-year period.

The taxable amount of your capital gain is calculated on your tax basis in the home you’re selling, which may or may not be the same as the purchase price. The capital gains tax rates in 2022 are:

- Single – 15% for taxable income up to $459,750 and 20% above that amount
- Married filing jointly – 15% for taxable income up to $517,200 and 20% above that amount

The 3.8% net investment income tax (NIIT) may apply to any gain above the gain exclusion limit if your modified adjusted gross income exceeds: