How Capital Gains Tax Law is Limiting Housing Inventory

[Brian J Allen]

There has been growing discussion about how capital gains tax laws are reducing the inventory of homes available for sale in high-appreciation areas. Specifically, homeowners who have lived in their properties for many years may find themselves financially disincentivized from selling due to the tax implications of their appreciated home values.

Consider the following example: A homeowner purchased a house 20 years ago for $250,000. Over time, the home has appreciated to $1.5 million. The homeowner, now older and living alone after the passing of a spouse, would like to downsize to a smaller home or condo that better suits their needs. However, upon selling, they would face a $1.25 million capital gain. Current tax law allows an individual to exclude $250,000 of that gain if they have lived in the home for at least two of the past five years, leaving them with a $1 million taxable gain. With a retirement and Social Security income of $65,000, they could owe approximately $260,000 in long-term capital gains taxes.

By contrast, if that same homeowner had moved every five years, upgrading to a larger home along the way, they would now own a property worth $1 million instead. Their capital gain would be reduced to $500,000, and after the same $250,000 exemption, they would only owe taxes on a $250,000 gain—resulting in a significantly lower tax bill of roughly $55,000.

This discrepancy effectively punishes long-term homeowners who have remained in their properties, disproportionately affecting those who may now find their homes unsuitable due to aging, changing lifestyle needs, or financial strain.

The capital gains tax exemption of $250,000 per person ($500,000 for married couples) has remained unchanged since 1997. If adjusted for inflation, that $500,000 exemption would be approximately $985,000 today. Increasing this threshold would likely encourage more longtime homeowners to sell, freeing up inventory in a housing market that is already struggling with supply shortages.

Revising this outdated exemption would not only provide financial relief to those who need to transition to more suitable housing but also help ease housing shortages by making more homes available to younger buyers. A simple policy update could have a profound effect on housing mobility and affordability, benefiting homeowners and prospective buyers alike.

[Sam Kahl]

Brian,

Great insight - this specifically hits those in HCOL hard (or anywhere that has seen higher than average appreciation).