Retirement Requires Smart Tax Moves

The following article is courtesy of California Association of Realtors.

DEAR BENNY: My aunt is 76 years old and lives in her home. She also owns a detached rental property nearby. Her primary residence has been the same property for more than 10 years. She would like to move into a retirement community this year, but to afford this new lifestyle she would have to sell one of her properties soon. Would it be more cost-effective from a tax perspective to sell her primary residence or her rental property? Are there any tax benefits to selling rental property vs. one’s primary residence? I have heard about a one-time tax exemption on the proceeds of selling one’s primary residence, but I do not understand the rules of this exemption. I was thinking it would be better to sell the rental property first to avoid inconveniencing my aunt’s daily routines, and later convert the primary residence into rental property after she moves. She could wait to sell one of the houses until the housing market improves. However, I would not want her to lose a tax exemption or tax benefit by making the wrong decision. –Arlene

DEAR ARLENE: If your aunt is married and files a joint tax return with her spouse, she can exclude up to $500,000 of any gain (profit) that she will make in the house. If she is not married — or files a separate tax return — she can exclude only up to $250,000 of gain. In order to take advantage of this gain exclusion, there are two tests: (1) ownership — you must be on title; and (2) use — you have to have lived in (used) the property for two out of the five years before it is sold. In your aunt’s case, she currently meets both tests: She owns the property and has lived there for a long time. However, if she rents it out and cannot sell within three years from the date she moved out, she will lose that tax benefit. You (or your aunt) should consult a tax advisor, who will prepare an analysis of the pros and cons of selling each house. Everyone’s financial situation is different, so I can provide only general advice. I suspect that your aunt has an accountant who has been preparing her tax returns each and every year. He/she should be able to quickly project the tax consequences regarding each house.

Benny L. Kass is a practicing attorney in Washington, D.C., and Maryland. No legal relationship is created by this column.