Downsizing or rightsizing?
Favorable tax laws, especially if you're 55, make it easier to 'buy down'

by Carol Blitzer

Harold (Skip) Justman was only 50 when he and his wife, Gail, sold their large Crescent Park house in 1998 and moved with their four children into a smaller one in downtown Palo Alto.

Suddenly, mowing the lawn, fixing the roof and keeping the big house clean no longer seemed as appealing as their children grew up.

The Justmans had purchased the Crescent Park home about 10 years before, so were paying post-Proposition 13 property tax of 1 percent of purchase price (plus annual inflation). The taxes on their new home were actually less than what they'd been paying.

Justman is a real estate lawyer who writes a monthly column for the Palo Alto Weekly on real estate and tax issues. He said he has heard a lot of stories from people who worried that they couldn't get into a smaller place in the same community without paying as much as they sold their old home for.
They feared they'd owe even more in property taxes. And then there's capital gains on the profit from the first house.

For the Justman family, the issues boiled down to the convenience of living in a smaller, more centrally located home versus the liabilities of capital gains and property taxes.

The Justmans decided not to wait until the nest was empty. They moved just as their oldest child was going off to college; two others were in high school and one in elementary school.

Upkeep on the new home is significantly easier. "I always did my own landscape gardening, but that gets tiresome after a while. Now we have bushes and plants, but no lawn. We used to have a huge lawn -- I filled three garbage bags with clippings every time I mowed the lawn. It was a lot of work," he said.

In addition, painting a large, two-story home was a "big event." Now it can be done on a ladder. "We don't need scaffolding. It's less intimidating to do things to the house," he added.

Justman grew up in Palo Alto and really wanted to stay nearby. Gail recently started working as a teacher's assistant with special-education children.

"She's just now starting a career that's fulfilling for her; we didn't want to move and give that up," he said.

"Having just done it, I can tell you there's a lot of emotional trauma associated with selling a house you've lived in for over 10 years. You just put down roots and it's traumatic to go through re-registering for voting, changing your mailing address with all your magazines -- there's a lot involved," he said.

Not to mention getting rid of things.

Justman and his family found themselves sorting through clothing, sports equipment and furniture -- asking themselves if they really need it. "There's so much we hold on to. If we really needed it, we could replace it," he said, mentioning his family's leftover paint cans and collection of old nuts and
bolts.

"The kids are just as happy in the smaller house. They're certainly happier with the location," he said.

Some people are concerned with what their friends will think, if they give up their big house, but Justman said his family was "thrilled" to be within walking distance of downtown Palo Alto.

"That was the big payoff. Yeah, we're in a smaller house, but we're happier and can walk downtown for dinner; my kids can walk to school," he said.

Will the new house be big enough over time? What about holidays? Family reunions?

"We'll all go out for dinner! What if the kids come back and visit? I'll rent a hotel room.

"Do I really want to continue to pay $10,000 per year in property taxes just so the kids will have a place to come back and visit?... Keeping a big house just so the kids can come visit is not the right economic decision. The right economic decision is to get rid of the big house," he said.

For most homeowners, the issue of downsizing doesn't arise until age 55, when more lenient tax rules kick in.

Justman said that, under current law, if you're married and filing a joint return, the first $500,000 in capital gains is tax free (both federal and state). The excess is taxed, but at a maximum rate of 20 percent for federal taxes. (Capital gains is figured on the difference between the selling price and what
you paid less improvements beyond regular maintenance.)

"I did not find that to be an onerous tax," he said. "When I sold in 1998, my gain was more than $500,000, but the tax wasn't all that burdensome, given you were given $500,000 free to begin with."

A second issue is property taxes. Those who purchased their homes before Proposition 13 (1978) enjoy a very low tax rate. "If you've lived in the house for a long time, your taxes are fairly reasonable," he said. Those who purchased in the 1980s also pay far less taxes than they would for a home at
today's prices. But if you're 55 or older you might not have to give up your old tax rate.

"You could sell an old house in Palo Alto and carry over the assessed (property tax) basis from old house to new house and (there would be) no change to property tax," he said. That is certainty if the person is moving within the same county. If moving from Santa Clara County to San Mateo
County, the homeowner would have to call the county assessor to see if keeping the same assessment would be allowed.

"Each county gets to decide if it wants to accept a low assessment for a new immigrant to its county," he added.

Giving up the big house isn't for everyone, Justman acknowledged. "If it's a rising market and you have a $2 million home and the market goes up 10 percent, you've made $200,000. If it's a rising market and your house is worth $1 million and goes up 10 percent, you've only made $100,000. The bigger homes can capture bigger appreciation.

"But the flip side of that is when the market goes bad, the bigger homes lose more value," he said.

"I sold in July '98 expecting the market had peaked. I was off by two years, but selling in July 1998 (snaps fingers) like that was a better experience than trying to catch the peak and miss it and sit on the house for nine months," he added.

"The replacement house is appreciating, not as much as the big house. If you sell and buy and replace in Palo Alto, you're still catching the appreciation. I could have gotten more in March 2000 than in '98. If I'd sold in '98 and put it in T-bills (or tech stocks), I'd have been hurt," he added. Even with the best financial reasons in the world for selling, moving still wasn't easy, Justman reiterated: It was "hard to do it at 50. I know (I) wouldn't have the emotional energy to do it at 60. Death, divorce, buying a
house, selling a house - (these are) right at the top of stressful events. As health is declining, you don't want to tackle this problem," he said.