The gains from selling a house are taxable. In addition, last I checked, 6% of the sale price is split between the buying and selling realtor. But the biggest factor here in California is the controversial Proposition 13. The assessed value of the property for tax purposes can only increase by 2% per year. Since real estate has appreciated in value much faster than 2%, an elderly couple like my parents are only paying about 1/10 of the normal tax rate.
The house my parents bought in 1975 is worth $4 million (according to Zillow) because it is in a prime Palo Alto location. In their case, assuming the house is actually worth $4M, they will make a tidy profit. They could buy a downsized house, but only if they move out of Palo Alto. And their tax bill would sky-rocket.
A better example might my house, which I have owned for 22 years, valued at a "mere" $1.4M. Taxes at market rate would be $12,320. Assuming I bought it in 1975, my yearly tax bill would be a mere $1,232. The first problem, small houses in the Bay Area are still expensive. But suppose I found something for $700K, my tax bill would go from $1,232 to $6,160. OK, maybe I move somewhere cheap, and get a house for $350K, I'm still probably paying more than 2x my current tax rate.
Add to that the enormous stress involved with buying a house, I'm not planning on selling, ever.
The first $500k is tax-free if married filing jointly. The rest is taxed at a maximum rate of 20%. For nearly $4m in profit, that's pretty good. There'll be cash left after selling. Pay the taxes. They've gotten a really good deal on property tax for decades, and will continue to do so in their new home (keep reading).
> 6% of the sale price is split between the buying and selling realtor
You don't have to accept the standard shit deal in a seller's market like Palo Alto. Negotiate. List directly on MLS. Sell off-market. There are so many possibilities.
> And their tax bill would sky-rocket
Prop 90 allows homeowners over age 55 to keep their original assessed value when selling and moving to a different home of equal or lesser value. [1]
To me it sure sounds like your parents could sell for $4m, buy a high-end condo in Mountain View or Sunnyvale for $1.5m, and have well over $1.5m left after taxes, closing costs, and moving expenses. And continue to enjoy low property taxes on their new place. Maybe I missed something though.
For one thing, in California, prop 13 means that property taxes on a newly purchased smaller home would be a lot more than a bigger/nicer home purchased decades ago. In a lot of other places, property taxes are similarly under-assessed on homes that were bought a long time ago, just not as egregiously.
Help me out with this. Their downsized home will cost less than their large home sells for.