Mortgage Rates Finally Drop to 7.32%. A Retiree Who Sells Now Could Still Face a Social Security Tax Surprise
Quick Read
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A home sale gain above the $250,000 single-filer exclusion raises adjusted gross income, which can make up to 85% of Social Security benefits taxable.
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In the example, a $700,000 sale with a $380,000 basis and $30,000 in costs leaves $40,000 of taxable gain after the exclusion.
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Timing the closing so it does not coincide with other large income events like IRA withdrawals or stock sales in the same year limits the Social Security tax hit.
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Read More: Avoid these 13 retirement mistakes before they derail your future (sponsor)
Mortgage rates finally eased on October 22, with Freddie Mac reporting a drop in the average 30-year fixed rate from 7.40% to 7.32%. Picture a 68-year-old who’s been waiting to downsize. He calls a listing agent, hoping the dip will bring buyers back. What he hasn’t considered is how the sale could make more of his Social Security taxable.
When a Home Sale Actually Creates Taxable Income
Three numbers tend to get mixed up. The sale price is what the buyer pays. The mortgage payoff only decides how much cash he walks away with, and it has no effect on his tax. What the IRS cares about is the gain: the sale price minus his adjusted basis (what he paid plus improvements) and minus his selling costs.
IRS Publication 554, the agency’s tax guide for seniors, says an eligible seller can generally exclude up to $250,000 of gain on a main home, or up to $500,000 on a joint return in most cases. Mortgage rates have no effect on either limit.
Run a Downsizing Example Before Listing
Say he sells for $700,000. His adjusted basis is $380,000, and agent fees and closing costs come to $30,000. That leaves a gain of $290,000.
As a single filer, he can exclude up to $250,000. That leaves $40,000 of taxable gain. Tax applies only to the gain. His taxable amount is the piece of gain above the exclusion, whether his mortgage is paid off or not.
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His Social Security Check Stays Intact
Federal tax law uses a formula called combined income to determine how much of his benefits are taxed. Combined income is his adjusted gross income (AGI), plus any tax-exempt interest, plus one-half of his benefits. The $40,000 gain goes into his AGI, so his combined income rises.
Once combined income tops certain federal thresholds, more of his benefit counts as taxable income, up to 85% under Section 86 of the tax code. The sale doesn’t reduce his Social Security benefit. Any additional federal income tax shows up on his return. IRS Publication 525, which covers taxable and nontaxable income, says the taxable part of benefits goes on line 6b of Form 1040. Whatever amount is included there is taxed at his regular rates.
The earnings test, which can withhold benefits from people who work before FRA, counts only wages and self-employment income, so profit from selling a home falls outside it. He is also past FRA, when the earnings limit from that point on is none. Only one tax year sees this added tax. If he has no gain the following year, his combined income goes back to normal.
Why the Closing Date Still Matters
He can control when the sale closes. Four things deserve attention:
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Other income in the same year. A large IRA withdrawal or a sale of appreciated stock in the same calendar year adds to the home gain and drives combined income higher. Moving one of them into the next year can keep any single year’s jump smaller.
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Improvement records. Every documented project, such as a new roof or a kitchen remodel, raises his basis and lowers his gain. Missing receipts can cost real money.
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Ownership and use. The exclusion requires that he owned and lived in the home for at least 2 years during the 5-year period ending on the sale date.
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Estimated taxes. Raising the tax withheld from his benefits, or making a quarterly estimated payment, can head off a surprise bill and penalties in April.
The rate dip might help bring more buyers into the market. The taxes on his benefits come down to his gain and the calendar year it lands in (this silent interaction between a home sale and benefit taxation is one of several we charted in a free retiree tax trap guide: here).
Compare Net Proceeds Before Treating the Dip as a Green Light
That 7.32% is the rate on his buyer’s loan. His own tax picture depends on the gain he locks in at closing. Before he signs a listing agreement, he should ask a tax preparer how much cash he’ll keep after paying off the mortgage and how the gain could affect his taxes, including those on Social Security.
The mistake that’s hardest to undo is closing in a year already full of other income. Each household’s basis, filing status and income mix is different, so his numbers may look quite different from yours.
Help Avoid These 13 Retirement Mistakes Before They Derail Your Future
One investment mistake could create big risks for your retirement. Many investors make the same critical errors: being too conservative, making big bets on “sure things,” or paying excessive fees. Any of those blunders can endanger your hard-earned savings.
Now you can learn the mistakes even experienced investors make (and ways you can sidestep them before it’s too late) with this new guide: 13 Retirement Mistakes and How to Avoid Them from Fisher Investments. (sponsor)
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