Will Congress Expand the Capital Gains Exemption to Help People Sell Their Homes?

Property values keep going up. Why doesn’t the capital gains exemption do the same?

Taxes on home sales can make deed holders hold their homes when they might otherwise sell. When current deed holders don’t want to sell their properties, inventory suffers. Meanwhile, there are young people looking for homes to buy.

Capital Gains Tax: Background

In 1997, federal lawmakers created a capital gains tax exclusion of up to $250K ($500K for couples).

The rule means couples who sell a home for more than what they paid for it pay no tax on any gains up to that amount, if they’ve made the home their primary residence for at least two of the recent five years.

A tax exemption of $250K per person doesn’t go as far as it used to, though. And Congress did not equip the provision to expand along with housing inflation. The result? Nearly 99% of sellers paid no capital gains tax in the early 2000s. Now, nearly 8% of deed holders are getting taxed on their profits when they sell.

The More You Gain, the More You Owe

Knowing the above facts, we can better understand the reluctance of older adults, especially couples, to sell. One major factor could be the fear of a large federal tax bill. After paying that bill, it can be difficult to find the cash for state taxes on the home sale.

So, couples might decide to wait until one spouse dies and then let the other inherit the home. Given the tax rules for heirs, capital gains will then be eased by the “stepped up” cost basis.

If a deed holder bequeaths a home to an heir, the Internal Revenue Service lets the heir declare a stepped-up cost basis. The heir to a deed who wants to sell it can use the home’s value when inherited as a cost basis when calculating the profits. This allows far less accumulated value to be taxed — often none.

Many baby boomers have seen a great deal of appreciation in their home values since the day they acquired their deeds. The tax code effectively puts a penalty on their good investments. This is the argument brought forth by those who want to see the ceiling raised on this tax break. Now, let’s take a look at who’s campaigning to update the tax law.

Real Estate Agents Press for Bigger Tax Exemption

“Capital gains tax reform” is one of the biggest priorities for the National Association of REALTORS® (NAR) right now as they lobby in Washington, D.C. NAR also has an online petition form. It asks members to show how the capital gains tax impacts deed holders and local markets. “These stories are crucial,” writes NAR, to get Congress to understand “the real-world effects of these outdated policies.”

Suzan DelBene of Washington state backs up the point NAR makes. The U.S. representative in Congress reports regularly hearing from constituents “who want to sell their homes but can’t afford to because of the significant tax bill they will incur.” DelBene says this does contribute to the shortage of homes for sale, which in turn presses the price tags on homes ever higher. It’s a feedback loop that hasn’t been addressed.

Meanwhile, NAR reports that older homeowners are getting hit with capital gains taxes amounting to tens of thousands of dollars. “By increasing the capital gains exclusion and indexing it for inflation,” NAR insists, the federal government could boost inventory for prospective buyers.

Inheriting a home? Here are a few things you need to know about inheriting, selling, and taxes.

Federal Lawmakers (on Both Sides of the Aisle) Add Their Voices to the Call

This year, U.S. Representatives Jimmy Panetta and Mike Kelly revived the More Homes on the Market Act. Due to housing inflation, “people who have chosen to downsize have been unfairly punished with massive tax burdens,” said Mike Kelly, who adds that deed holders should get to hold onto “more of their hard-earned money during their golden years.”

The proposed new law would adjust the tax code so that capital gains taxes don’t have to be paid on profits up to $500K ($1 million for joint filers). In short, the updated tax code would double today’s exemption. This would respond to inflation. The lawmakers say it would also lead to more primary residences being listed and released into the market. 

Joining Panetta and Kelly in their sponsorship are Representatives Nicole Malliotakis of New York, Suzan DelBene of Washington state, Indiana’s Rudy Yakym, and Lou Correa in California. “Seniors shouldn’t have to pick”, says Correa, “between downsizing their homes and having to foot an enormous capital gains tax bill.” Rep. Yakym says the bill offers “tax relief for seniors and others looking to downsize by doubling the capital gains tax exclusion for the sale of a principal residence.”

Our Takeaways on Capital Gains and the Tax Code

Mortgage rates remain elevated. Price tags on homes can be daunting to say the least. Millions of people are sidelined from the market, while long-time deed holders feel stuck in place because they believe selling their homes won’t make financial sense.

When long-term deed holders do consider selling, they might balk at the taxes they’ll owe on their profits. The push to double the IRS exemption is one way lawmakers signal to voters that they’re acting on housing affordability. In any case, people with heavy profits on home sales will be the winners in the capital gains tax reform game. But will the change put a meaningful dent in the affordability crisis?

There’s some irony here, too, on the dynamic of lawmaking. This is not the first time the federal reform bill has appeared in Congress. If deed holders keep hoping reform legislation will pass, some could be delaying their home sales, because they’re in “wait and see mode” with regard to their chances of getting a bigger break.

Finally, it’s important to remember that state taxes on profits (where applicable) can bite harder than federal taxes.