To Everything There Is a Season — Is Downsizing on Your Horizon?

“To everything (turn, turn, turn)
There is a season (turn, turn, turn)
And a time to every purpose, under heaven
A time to build up, a time to break down
A time to dance, a time to mourn
A time to cast away stones, a time to gather stones together”

“Turn! Turn! Turn!” written by Peter Seeger and made famous by The Byrds was released in 1965. If listening to this song on the AM station was part of your high school memories, then you are probably thinking about downsizing or soon will be. Downsizing is a time to break things down and a time to cast things away. Hopefully there will be some laughter and dancing and not too much to mourn, but probably some tears are inevitable.

My professional life has provided the great privilege of working with clients throughout various seasons of life, and downsizing is inevitable for most. Like every chore, some enjoy the process, while for others it is more difficult. The intimidating task of parting with things that connect to those you love and have accumulated in your home over the decades is difficult.

It seems wise to understand there are many going through these sometimes-difficult transitions and that seeking help and assistance makes good sense for many of us.

Downsizing Real Estate

Wall Street Journal’s article “Downsizing Your Home is Hard. How to Decide What’s Worth Keeping” has some great tips about how to logically think about downsizing a home. Thus, let me focus on the tax aspects of it.

When changing homes, we want to look at the current state of different borrowing needs. For instance, should you borrow short term using a pledged asset line of credit, take advantage of low interest rates and lock into a mortgage, liquidate some of your portfolio, or do some combination of thereof? We want to make sure this decision is made for each client in the most tax-efficient way.

Many clients who have been in the same home for decades should be mindful of the tax rules for reporting the sale of a principal residence. First, note that the sale must be reported on your tax return. This means that your tax preparer will need the closing statement when preparing your income tax return in the year of the sale. Secondly, you will need to provide the cost basis of your home to your tax preparer. Your cost basis is what you originally paid for the home plus significant additions over the years. Coming up with this information can be a daunting task for clients who have been in their home for many years. Your tax professional can assist you and note that the American Institute of Certified Public Accountant’s Statements on Standards for Tax Services allow CPAs to use estimates when not prohibited by any statutes or rules. Accordingly, your CPA can rely on a reasonable estimate of cost basis if you do not have exact records.

The tax rules provide for an exclusion of the gain resulting from the sale of a taxpayer’s principal residence of $500,000 for those filing joint returns and $250,000 for those filing as single taxpayers. The exclusion is available to taxpayers who have owned and used the residence as their principal residence for at least two years during the five-year period ending on the date of the sale. There are other exceptions, but these basic rules apply to most clients.

If you are in the unfortunate position of having to sell your home at a loss, the tax rules are not helpful. You are not able to deduct the loss on the sale of personal-use property.

Downsizing Objects via Donation

I recently wrote a separate article about tax considerations for donations. Specifically, for donating objects of substantial value there are three things to keep in mind:

  • When making your donation of cash or goods, be sure to get a receipt. The IRS requires a receipt for donations greater than $250. For donations under $250, you need to have supported documentation, such as a bank record or receipt documenting the contribution.
  • For donated property with a value of more than $5,000, you’re generally required to obtain a qualified appraisal and to attach an appraisal summary to the tax return. However, a qualified appraisal isn’t required for publicly traded securities for which market quotations are readily available. For non-publicly traded securities, a written appraisal is required only when the deduction claimed exceeds $10,000.
  • For gifts of art valued at $20,000 or more, you must attach a complete copy of the signed appraisal (rather than an appraisal summary) to your return.

Downsizing Objects via Estate Planning

Many clients might be in a position such that downsizing must be done with an eye on estate and gift tax implications. You might have valuable art objects, antique furniture, or jewelry that you wish to pass along to your children as you downsize. At a minimum, making a gift can create the need to file a gift tax return and, depending on the situation, could very well impact your estate plan. I also encourage you to discuss your gifting intentions with your loved ones to ensure they want it. If not, it likely does not make sense to take on the tax liability.

Clients should be mindful that gift tax returns are required for gifts to any one individual that exceed the annual exclusion ($16,000 in 2022). If the property gifted is of significant value, it is prudent to obtain appraisals from qualified professionals to substantiate the amount of the gift, which is the fair market value on the date of the gift. The appraisal should be attached to the gift tax return, which is a calendar year return due on April 15 just like your individual income tax return. Although the amount of the gift is the fair market value on the date gifted, the cost basis of the gift in the hands of the recipient is the carry-over basis from the donor.

It is the donor who is responsible for filing gift tax returns, and if there is tax that must be paid it is the donor who is responsible. Finally, it is important to note that there is a generation-skipping tax that should be considered if making gifts to grandchildren.

The estate and gift tax rules comprise a transfer tax. Many observers think it likely there will be significant changes in the gift and estate tax rules on the near horizon due to the recent change in leadership in congress and the white house. Currently a taxpayer can transfer over $11 million by lifetime cumulative gifts or through their estate without having to pay gift or estate tax even though gift tax returns are required each year if the reporting requirements are met.

The comments offered are a sufficient reminder that gift and estate taxes and associated non-tax implications can quickly become complicated. Accordingly, your attorney and Parsec advisor and team should be consulted when your downsizing is done by way of gifting personal property to children or to others.

If you aren’t a Parsec client, we invite you to learn how we work with retirees.


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