CORRECTION: An earlier version of this article misstated how the outstanding mortgage balance factors into the taxable gain from the sale.CORRECTION: An earlier version of this article misstated how the outstanding mortgage balance factors into the taxable gain from the sale.

Dear Tax Guy,

We plan to sell our home in Sammamish, Wash., which is worth around $1.4 million. We still owe a $310,000 mortgage. We will use the proceeds to buy a house in Orange County, Calif. to be closer to family and relatives.

We bought it in 1996 for $230,000, and made a series of house improvements costing $120,000. Between moving and buying a new home in California as seniors, please help us navigate any taxes we face.

What tax incentives should we expect — now that we both are over 65?

California Dreaming

Dear Dreaming,

This is a major move in your life and I hope you find a great spot that’s close to your nearest and dearest. It’s also a big tax move for you — and many senior citizens like you. There’s going to be a “silver tsunami” as baby boomers, generally between age 59 and 77, downsize.

Let’s box up your tax situation as you start packing your belongings:

Box 1: Federal capital-gains taxes

Assume you get $1.4 million for your home. Median sales prices in Sammamish’s housing market were $1.8 million in May and up more than 13% from a year ago, according to Redfin.

The capital gain is your profit after accounting for your cost basis. If it’s your primary home, a chunk of the profits skip capital gains taxes. For single filers, the first $250,000 in profits are free of capital gains and it’s $500,000 for married couples.

Certain home improvements will increase your cost basis, according to the IRS. That includes upgrades for bedrooms, bathrooms, decks, garages, central air conditioning, furnaces, flooring, fences, swimming pools and more. Hold onto the receipts, in case the IRS wants proof.

What cannot be included are repairs and upkeep that keep your house functioning but don’t make it more valuable to potential buyers. Painting doesn’t boost the cost basis nor do fixes to leaks, the IRS says. (But you can include the costs of selling your home.)

Assuming the IRS considers all your $120,000 in improvements as increases on your original $230,000 purchase price, that’s a $350,000 cost basis. So let’s run the numbers. If you can fetch $1.4 million (lucky you) with a $350,000 cost, that’s just over $1 million in profit.

With a 15% rate, you face roughly $80,000 from the federal capital gains after the give and take on the margins for final price and costs, according to one count.

But there’s still the $310,000 to pay off the remaining mortgage balance.

The outstanding mortgage has no impact on the tax scenario, said Rob Seltzer, president of Seltzer Business Management in Los Angeles. There’s still a taxable gain that’s just over $1 million to deal with, he said.

Given that you are a “we” and (presumably) married, you are poised to avoid capital gains on the first $500,000 in profits. The remaining $550,000 would be subject to capital-gains taxes, which could be either 0%, 15% or 20% depending on the rest of your income.

It’s more likely to be the middle rate. The 15% rate is a wide band encompassing a lot of people. For a married couple filing jointly, the 15% rate this year applies to households with an annual taxable income between $94,051 and $583,750.

Meanwhile, that remaining $310,000 mortgage is reducing the net after-tax cash, Seltzer said.

With a 15% rate, you face roughly $82,500 in taxes from the federal capital gains after the give and take on the margins for final price and costs, Seltzer said. The IRS always gets its cut, but a sum like that is a small price for a nice return on your investment.

After some quick calculations, assuming a $1.4 million sale on this home purchased in 1996, it gives you a roughly 5% return on your home’s value each year, Jennifer Baick, vice president, financial planning group, at Mercer Advisors noted.

Box 2: Washington state taxes

Your state has a relatively new capital gains tax. But the profits from home sales are exempted from this capital gains tax, according to Washington’s Department of Revenue. There’s also no state income tax in Washington. But state and local real-estate excise taxes will apply.

Box 3: California income taxes

You’re poised for a nice profit from your home sale. But be prepared to pay dearly to find an Orange County address. The median sales price for homes in the county was $1.2 million in May, which is an 18% increase year over year, according to Redfin.

Unlike Washington, the Golden State levies income taxes. But your home sale in Washington state proceeds should not be subject to California’s income taxes, said Seltzer.

That’s as long as you do not become California residents before you sell your Washington home, he said. “It appears that their residency would commence after the sale of the property,” he told MarketWatch in an email.

Box 4: Tax breaks in California 

California is one of many states that does not tax Social Security income. At the federal level, the monthly payments become taxable once a married couple’s “combined income” exceeds $32,000 per year.

You asked about the potential tax breaks and incentives for California residents above age 65. California does offer some tax credits, like the Senior Head of Household Credit, intended for older residents with special circumstances and income eligibility caps. 

At the local level, Orange County and other California counties have property-tax programs for certain blind, disabled and elderly taxpayers. These programs defer the property tax payment, but generate a lien on the property that ultimately needs to be repaid.

Requirements include at least 40% equity in the home and an annual income under $51,762, according to the California State Controller. It’s worth asking a California tax expert to see if there are any other provisions for you.

But even if these seem like a narrow set of tax-trimming opportunities, it’s still worth it. The biggest opportunity is your chance to be near family.

Got a tax question? Write me at: [email protected]

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