Taxes are impacting more folks who sell their homes, particularly if the property has seen a significant increase in value.
Since 1997, most home sellers have been able to exclude from capital gains taxes up to $500,000 of the profit made when selling a primary home. But that limit has never been indexed for inflation.
As a result of appreciating property values, a recent analysis by the National Association of Realtors (NAR) shows that 29 million American homeowners — roughly 34% — have now built up enough home equity to exceed the $250,000 individual capital gains exclusion.
Thanks to the Taxpayer Relief Act of 1997, homeowners who have a capital gain when they sell their homes can exclude up to the following amounts from taxation:
- $250,000 for single individuals
- $500,000 for married couples filing jointly
As the IRS states:
“You’re eligible for the exclusion if you have owned and used your home as your main home for a period aggregating at least two years out of the five years prior to its date of sale.”
However, the rapid rise in home prices since the COVID-19 pandemic means more homeowners are routinely exceeding these historical limits.
Industry advocates, including the NAR, point out that this is heavily contributing to a “stay-put penalty” in the housing market:
“Seniors in appreciating markets — many of whom have spent decades in their homes — are delaying moves they might otherwise make. Downsizing, relocating closer to family or shifting into assisted living can become a costly and sometimes impossible proposition, thanks to looming tax bills.”
This issue is magnified depending on where you live.
While early 2020s data showed just a small fraction of national sales breaking the exclusion limit, NAR’s recent state-by-state data paints a stark picture of current homeowners who have already built up enough equity to exceed the $250,000 individual limit if they sold today.
The most heavily impacted states include:
- Hawaii: 79.1%
- Washington: 64.8%
- Massachussetts: 62.3%
- California: 62.2%
- Colorado: 59.5%
- Idaho: 54.9%
- Montana: 53.6%
- Oregon: 51%
- New Hampshire: 50%
- Arizona: 48.5%
The NAR estimates that by 2035, 20 states will have over 40% of their homeowners facing these tax penalties.
Today, Americans are sitting on roughly $34.7 trillion in home equity, making the 1997 limits a hurdle for more states.
To address the shrinking value of the exclusion and break up the logjam of housing inventory, lawmakers are pushing for an update.
Bipartisan legislation, such as the More Homes on the Market Act championed by Rep. Jimmy Panetta (D-CA), aims to double the current exclusions to $500,000 for single individuals and $1 million for married couples, while finally indexing the limits to future inflation.
For more on rising prices and how they impact your tax return, check out “Stealth Tax Hikes: 7 Ways Inflation Dings Your Deductions.”
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