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“We’ve lived here 35 years. The kids are gone. We’re selling the house and moving somewhere smaller. Do we owe tax on that?”
Let’s say that’s Ed and Margaret, both 68 and married, filing jointly. They’re not real people, but their situation is a familiar one. They bought their home in 1991 for $120,000, and today it’s worth $780,000.
I’ve been a CPA since 1981, and here’s the short answer: probably yes, and it’s easy to miss.
The IRS lets a married couple filing jointly exclude up to $500,000 of gain on the sale of a main home, or up to $250,000 for a single filer, if they pass the ownership and use tests. (1) Sounds like plenty. It isn’t always.
“Since 1997, those thresholds have never been indexed for inflation,” CNBC reported in 2025. (2)
The same report cited National Association of Realtors estimates that some 29 million homeowners, or 34%, could exceed the $250,000 threshold for single filers, and 8 million, or 10%, could top the $500,000 limit for couples. (2)
Ed and Margaret are in that 10%. Here are the 5 things I’d tell them before they list the house.
1. Run the real numbers first
Your taxable gain isn’t the sale price minus what you paid. The IRS starts with the selling price, subtracts selling expenses to get the amount realized, then subtracts your adjusted basis. (3)
Say Ed and Margaret pay $45,000 in selling costs and have $40,000 of documented improvements. Their basis is $160,000. My math: $780,000 minus $45,000 minus $160,000 is a $575,000 gain. Take away the $500,000 exclusion, and $75,000 is taxable.
Long-term capital gains are taxed at 0%, 15% or 20%. For 2025, the 15% rate covered married couples with taxable income over $96,700, up to $600,050. (4)
If their other income already fills the 0% bracket, that $75,000 costs them about $11,250 in federal income tax, plus any state tax, and possibly the 3.8% net investment income tax if their income is high enough. (6)
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2. Every receipt for a new roof is worth money
The IRS says, “You add the cost of additions and improvements to the basis of your property.” (3) Its examples include additions, landscaping, systems and a new roof.
That matters. If Ed and Margaret can’t document that $40,000 of improvements, their basis drops to $120,000, their taxable gain rises to $115,000, and their tax at 15% climbs to $17,250. By my math, the shoebox of old receipts is worth $6,000.
So before you sell, dig out those records: contractor invoices, permits, canceled checks. Repairs generally don’t count, but improvements do. (3)
3. Report the sale even if you owe nothing
It’s tempting to assume a tax-free sale doesn’t go on the return. Not always. The IRS says if you receive a Form 1099-S, “you must report the sale of the home even if the gain from the sale is excludable.” (1)
And if part of the gain is taxable, as it is for Ed and Margaret, it goes on the return for sure. (1) Don’t let a surprise IRS letter be how you find out.
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4. Watch the 2-year clock, especially if a spouse dies
To get the exclusion, you generally must have owned the home and lived in it for at least 24 months of the 5 years before the sale. (1) Ed and Margaret clear that easily.
The clock that catches people is the one for widows and widowers.
A surviving spouse who hasn’t remarried may still claim up to $500,000 if the home is sold within 2 years of the spouse’s death, according to the IRS. (3) Wait longer, and a single filer’s exclusion is generally $250,000.
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5. Sometimes the best tax move is not selling
Here’s the part that surprises people. If Ed and Margaret keep the house until they die, their heirs generally get a new basis. The IRS says inherited property’s basis is generally “the fair market value of the property at the date of the individual’s death.” (5)
In plain English, the built-up gain can disappear for the kids. That doesn’t mean you should stay in a house that no longer fits your life. It means the tax is one more thing to weigh against the stairs and the yard work.
My honest take
Downsizing is usually a smart move. Smaller house, smaller bills, less to maintain. But a $500,000 break that hasn’t changed since 1997 isn’t the free pass it used to be.
Do the math before you list, find your receipts and know your deadlines. Then sell with your eyes open.
For many of us, a house is the biggest thing we’ll ever own. It deserves more than a guess at tax time.
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