“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 early 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.
“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”
Just like every season in life, 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’s 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, liquidate some of your portfolio, or do some combination 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 (or, if you inherited the home, the market value at the decedent’s date of death) 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 – 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.
Section 121 of the Internal Revenue Code provides for an exclusion of the gain resulting from the sale of a taxpayer’s principal residence of up to $500,000 for those filing joint returns and up to $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 via Donation
Specifically, for donating objects of substantial value, there are several things to keep in mind:
- When making your charitable donation of cash or goods, be sure to request an acknowledgment from the charity. The IRS requires such an acknowledgment for donations of $250 or more. For donations under $250, you need to have supporting documentation, such as a bank record or receipt documenting the contribution.
- With the exception of publicly-traded securities, for a donation of property with a value of more than $5,000, you’re generally required to obtain a qualified appraisal, and to complete Section B of Form 8283, which will be signed by a qualified appraiser and the donee organization. This $5,000 appraisal threshold applies per item or per group of items (such as clothing, stamp collections, books, etc.)
- 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.
- If you are considering donating a vehicle, keep in mind that the deduction amount is dependent upon how the charity uses the vehicle. If the charity sells the vehicle without any significant intervening use of or material improvements to the vehicle, the charitable deduction is limited to the gross proceeds of the sale. If the charity sells the vehicle at a significant discount (or gives the vehicle) to a needy individual, you may claim a deduction in the amount of the fair market value (FMV) of the vehicle, if the charity’s charitable purpose is to help the poor, distressed, or underprivileged in need of transportation. If the charity instead uses the vehicle to further its charitable activities, you may claim a deduction for the FMV of the vehicle. You should obtain Form 1098-C from the charity and include it as an attachment to your tax return.
Downsizing 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 artwork, 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. Also, 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 potential tax liability.
Clients should be mindful that gift tax returns are required for gifts to any one individual that exceed the annual exclusion amount ($17,000 in 2023). 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 15th of the following year. 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. Conversely, the tax basis of an inherited asset in the hands of heirs is generally the fair market value at the decedent’s date of death. Therefore, careful consideration should be paid to highly appreciated assets in determining whether to make a lifetime gift to an heir or heirs versus leaving the assets for the heirs to inherit.
The donor is responsible for filing gift tax returns and paying any gift tax due. 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. Currently, a taxpayer can transfer over $12 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. This combined estate and gift exemption amount is set to revert back to $5 million (plus an inflation adjustment) on January 1, 2026, under current law.
The comments offered are a reminder that the tax implications of downsizing can quickly become complicated. Accordingly, we recommend consulting with your attorney and your Modera advisory team if or when you begin to think in earnest of downsizing.
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