Trading Down to a Smaller Home: What the Numbers Can and Can't Show

Many homeowners reach a point where the house feels bigger than the life in it. If the home has grown in value, a natural question follows: would selling it and buying something smaller leave the household better off? It can, but not automatically. The move frees equity and may trim some running costs, while selling, buying and moving each carry real costs of their own. Whether the exchange works depends on how the numbers compare and on things that never appear in a spreadsheet.

Key takeaways

• Trading down can turn home equity into cash and lower some yearly costs, but selling and buying both carry one-time expenses.
• In a hypothetical example, about $51,500 of one-time costs is set against about $3,800 a year of lower running costs.
• The recurring savings alone may take more than a decade to offset the cost of the move, so freed equity and lifestyle often drive the decision.
• The IRS lets many sellers exclude part or all of the gain on a main home, within limits that depend on filing status and how long the home was owned and lived in.
• A smaller home can add its own costs, such as association fees, so it helps to compare full monthly costs and not only the purchase price.

What "trading down" changes

Trading down means selling one home and buying a lower-priced one. Four things tend to change at once:

• Equity: some of the money tied up in the old home becomes cash.
• Running costs: property taxes, insurance, utilities and upkeep often fall with a smaller property.
• New costs: association or condominium fees, if the new home has them, can offset part of the savings.
• Lifestyle: less space and less maintenance, possibly a different neighborhood or community.

A hypothetical comparison

For example, suppose a household owns a $600,000 home with a $150,000 mortgage balance and is considering a $350,000 home that it would pay for in cash. These figures are illustrations, not averages or quotes.

One-time costs, using assumptions:

• Selling costs at 6 percent of the price: $36,000.
• Closing costs on the new home at 3 percent: $10,500.
• Moving: $5,000.

That is about $51,500 in total. After paying those, the mortgage and the $350,000 purchase, roughly $48,500 of the original equity would remain.

Now compare yearly running costs, again as assumptions. The current home might cost about $17,400 a year in property tax, insurance, utilities and upkeep. The smaller one might cost about $13,600 even after adding $4,200 a year in association fees. That is roughly $3,800 a year, or about $317 a month, lower.

The result is worth noticing. At that pace, the lower running costs alone would take more than 13 years to cover the one-time costs of the move. For many households the real appeal is not the monthly savings. It is the cash that becomes available and the simpler way of living. The example also leaves out what the household would do with the freed money, any change in property values, and the loss of a home it may love.

Taxes on the gain

The Internal Revenue Service explains that many people can exclude part or all of the gain from selling a main home. In general, up to $250,000 of gain can be excluded, or up to $500,000 on a joint return, if the owner meets ownership and use tests over the five years before the sale. There is also a limit on using the exclusion repeatedly within a short period.

Here is why this matters. If the hypothetical home had been bought years earlier for $250,000 and improved by $50,000, the gain after selling costs would be about $264,000. That is above the single-filer limit and below the joint limit. Which figure applies, and what counts as an improvement, are questions for a tax professional, not for a general article.

Questions to ask before deciding

1. What would the full monthly cost of the new home be, including fees, taxes and insurance?
2. How much cash would remain after every one-time cost, and is that cushion comfortable?
3. How long does the household expect to stay in the new home?
4. What would the freed money be used for, and what are the risks of that use?
5. What would the tax result be, based on the owner's real purchase price, improvements and filing status?
6. What does the household value that does not fit in a spreadsheet, such as nearby family, a community or a garden?

Trading down is one of several paths. Some households stay, some rent for a period, and some stay and change how they use the space. None is right for everyone. A clear look at costs, taxes and priorities makes the choice a considered one.

Common questions

Does selling a big house and buying a smaller one save money?

It can lower costs such as property taxes, insurance and utilities, and it may free up cash from home equity. Selling, buying and moving are also expensive, so the net result depends on prices, fees and how long you stay.

Do I owe tax when I sell my home for a gain?

The Internal Revenue Service says many homeowners can exclude up to $250,000 of gain, or up to $500,000 on a joint return, if they meet ownership and use tests. Your own situation may differ, so a tax professional can tell you how the rules apply.

What costs come with downsizing besides the new price?

Common ones include selling costs, closing costs on the new home, moving expenses, and any association or condominium fees. Property taxes and insurance on the new home may also be higher or lower than on the old one.

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