Many people fantasize about financing a good chunk of their retirement by selling their current home, buying a smaller place and investing the difference for income. In reality, however, they often reap far less profit than they might have hoped.

Done right, downsizing can still be a good idea. You might not only walk away with more money, but also simplify your life and reduce your home-maintenance and utility costs for years to come. To reach that happy outcome, you need to steer around the unexpected pitfalls that make downsizing so dicey. Here are four traps that await downsizers, with ways to avoid each.

1. Overestimating What Your Current Home Is Worth

It's easy to fantasize about the high price your house will fetch. Perhaps the neighbors down the street sold theirs for an extravagant sum, or so they said, and were last seen packing their new Bentley and heading for Acapulco. Chances are you don't know (a) what they actually netted from the deal; (b) how their home differs from yours in qualities prospective buyers most value; or (c) whether the real-estate market at that point was better or worse than it is now.

A late 2012 survey by HomeGain, a real-estate website, found that 75% of would-be home sellers overestimated what their homes were worth, according to their real-estate agents. The largest portion, 36%, pegged their home's value at 10-20% more than the market was likely to deliver.

What to do instead: Consult several local real-estate agents to get a dispassionate estimate of your home's current market value. More than one is important: An agent who desperately wants your listing might give you too rosy an estimate. You could also hire an independent appraiser.

Any number of websites, including Realtor.com and Zillow.com, will give you information on what homes in your area have sold for recently. You can also use online estimators from major banks, such as Bank of America and JP Morgan Chase, to determine a home's value. As with real-estate agents, it's best to check several of these, in part because they use different formulas to arrive at their estimates.

When you're talking to the agents or appraisers, ask about inexpensive things you can do to boost your home's selling price. Most experts say that major renovations aren't a good idea, unless your home is a total wreck, because they rarely recoup their cost. In Remodeling's "2014 Cost Vs. Value Report," even the project that recouped the most of its value, a new steel entry door, lost money, though it came close to breaking even at 96.6%. Other projects fell far short of that. New vinyl windows recouped just 78.7%, for example, and a bathroom remodeling just 72.5%. The lesson here: Save yourself the money and the hassle and let your home's next owners deal with those kinds of projects; their tastes may differ from yours anyway.

Still, a few simple spruce-ups, such as fresh paint here and there, pruning overgrown shrubs and de-cluttering your home from top to bottom can be worth the effort. If you wish, you can engage the services of a professional home stager to help you. For free advice on the topic, just do a web search on the phrase home staging.

2. Underestimating What a New Home Will Cost You

Just as people tend to be optimistic about what their homes will sell for, they're likely to imagine that they'll get a steal on the next place they buy. It's worth remembering that the potential buyers of your current home – and the sellers of your next one – are thinking just the same way.

What to do instead: Use the tools listed above for researching recent sales prices to find what you can expect to pay for the type of home you plan to buy. If you're thinking of moving to a new area, however, there's no substitute for spending some time there and visiting potential homes. Even if you're familiar with a place from vacationing there, it could pay to visit in different seasons to make sure you'll be happy there year-round. A prudent course, if you have the time, is to move to the area and rent for a year or so before buying. Far too many retirees move on impulse, regret their decision and end up calling for the moving van again.

Beware of costly add-ons that could boost the price of your new home beyond the estimates. It's easy for a new two-bedroom condo in some areas to approach the price of a four-bedroom house, especially if you decide to treat yourself to all the latest amenities.

3. Ignoring the Tax Implications

Unless you make a whopping profit on the sale of your home (and if you do, congratulations), you may not owe any income tax on the profit. Current IRS rules allow most couples to exclude up to $500,000 in gains from their taxable income. Singles can generally exclude up to $250,000.

The rules also take into account how long you've owned and lived in the home, among other factors. They're all explained in IRS Publication 523, "Selling Your Home."

Even if you don't owe income tax, there are other tax considerations to factor in before you choose to move. Some popular retirement destinations have high property taxes. A location with low property taxes might have higher sales or income taxes, or it might tax your pension income differently.

What to do instead: First try to determine your likely gain. That's not just the difference between what you paid for your home and what you sold it for, but the difference between the selling price and your home's cost basis. Cost basis includes what you paid initially plus any permanent improvements you made over the years. IRS Publication 523 explains those too.

Compare the income and property taxes of where you plan to move with those of your current location. Also look into any special breaks for homeowners over a certain age. The state's tax or revenue department website is a good place to start. Figure the new tax situation into your retirement budget and see whether it will cut your tax bill or result in in a higher overall tax burden.

4. Forgetting About Closing Costs

If it's been years since you bought a home, you may have forgotten all the closing costs you had to pay at the time. Those probably included legal fees, recording fees, title insurance and a long list of miscellaneous other charges. Not only will you have to pay closing costs when you buy your next home, you'll also be faced with a second set as a home seller. Most significantly, those can include real-estate commissions as high as 6%, and sometimes higher, if you use an agent.

What to do instead: Agent commissions can be negotiable, so try to get the most favorable possible figure nailed down at the outset. As a buyer, you might be able to persuade an eager seller to absorb some of the closing costs, but bear in mind that whoever buys your home will probably try the same maneuver on you. Otherwise, plan to bring your checkbook and write a lot of checks.

The Bottom Line

Downsizing your home can be a way to free up some additional cash for retirement, but run the numbers before you start packing. You may find ways you didn't realize that will save you money on the switch. Or you could decide it pays to retire in place, at least for now.