Downsizing in retirement: the tax and money decisions

When you sell your main home, up to $250,000 of gain is free of federal tax, or $500,000 for a married couple filing jointly, as long as you’ve owned it and lived in it for at least two of the five years before the sale. Many long-time owners in expensive markets now have gains above that, and the taxable part can raise both the tax bill and Medicare premiums two years later. The bigger question is usually not tax at all: how much money the move really frees up once the costs of selling, buying and moving are counted, and what that money is for.

The home sale exclusion

The rules, from IRS Publication 523:

• Two of five years. You must have owned the home and used it as your main home for at least 24 months of the five years before the sale. The two periods don’t have to be the same.
• Once every two years. You generally can’t use the exclusion if you used it on another home in the two years before.
• Widowed owners keep the higher amount for two years. A surviving spouse who hasn’t remarried can exclude up to $500,000 if the home is sold within two years of the spouse’s death.
• Care facilities count. If you lived in the home for at least 12 months of the five years and then moved into a licensed care facility, the time there counts toward the two years.
• Losses don’t help. A loss on your main home isn’t deductible.

There’s no extra exclusion for age: the same amounts apply at 45 or 85.

Working out the gain

Gain is the sale price, minus selling costs, minus your basis: what you paid, plus improvements. Improvements are work that adds value, extends the home’s life or adapts it to a new use, like a new roof or an addition. Repairs and upkeep don’t count. Records of 30 years of improvements are often the cheapest tax savings a downsizer has, so start gathering them before you list. See cost basis.

In this example, the $160,000 taxable gain is a long-term capital gain. If it pushes the couple’s modified adjusted gross income above $250,000, the 3.8% net investment income tax applies to the part above that line ($200,000 for a single filer). The excluded part of the gain is exempt from it.

The Medicare effect, two years later

Medicare sets Part B and Part D premiums from your income two years earlier. In 2026 Part B is $202.90 a month up to $109,000 of income for a single filer or $218,000 joint, rising in steps to $689.90. A taxable gain like the one above could move a couple up two or three brackets for one year.

Stopping work, a divorce or a spouse’s death let you ask Social Security to use newer, lower income. A home sale doesn’t. So if you can choose the year, avoid stacking the sale on top of a large Roth conversion or other capital gains. More in our guide to going on Medicare.

Sell now, or keep the house for heirs

If you’d owe tax on a large gain, holding the home until death changes the math: heirs generally inherit it with a basis reset to its value at that date, the step-up in basis, which wipes out the gain. That can argue for renting it out, or for staying, when the gain is far above the exclusion. It’s a trade between a tax saving for heirs and the money, ease and safety a move gives you now. An advisor should put both in numbers, along with the estate plan.

What the move actually frees up

Downsizing is often expected to release a large sum, and it often frees up less:

• Selling costs. Agent commissions, transfer taxes, repairs and staging.
• Buying costs. Closing costs and moving, and in a new community, entrance fees, HOA dues or service charges that may be higher than your old upkeep.
• The new home’s price. In many markets, a smaller home in a convenient place costs nearly as much as the larger one.

Count the yearly running costs too. A move that frees $200,000 but adds $800 a month in fees uses up a large part of that sum over 20 years.

Then decide what the money is for: paying off debt, a reserve for future care, or investments to add to retirement income. Added to a portfolio, $300,000 at a 4% withdrawal rate supports about $12,000 a year.

State rules can change the answer

Property tax rules vary by state and can outweigh the federal tax. In California, under Proposition 19, owners 55 and older can transfer their old home’s taxable value to a replacement anywhere in the state, up to three times, if they buy within two years of selling. A replacement worth more than the old home has some of the difference added. Other states have their own programs, so ask the county assessor in the place you’re moving to before you sign.

Common mistakes

• Not keeping improvement records. They lower the taxable gain dollar for dollar.
• Selling in the same year as a Roth conversion. The combined income can raise both tax and Medicare premiums.
• Buying first without a plan for the gap. Carrying two homes, or a bridge loan, eats into the proceeds.
• Moving away from family, doctors or care to save money that the move doesn’t actually save.
• Spending the proceeds without a plan. A lump sum in a checking account tends to disappear.

Questions to ask a planner

When a fee-only advisor is worth it, and what it costs

A planner is worth hiring before you list the house, not after: the year of the sale, the records, the tax and the use of the proceeds are all decided in advance. A fee-only planner doesn’t earn more if you put the proceeds into an annuity or under their management.

Hourly planners charge a median $300 for a narrower question like the year of sale. A one-time plan at a median $2,000 (middle half $845 to $3,600) fits if the move is part of a wider retirement plan. Ongoing planning runs a median $4,500 a year. Before handing the proceeds to an advisor who charges a percentage of assets, compare that fee with a flat one; see whether 1% is too much.

How to find one

Start with advisors for retirees or pre-retirees, the retirement planning and tax planning specialties, or the retiree audience page. If you’re downsizing to help an older parent, read our guide for aging parents.