Lawmakers look to expand capital gains tax exemptions as housing prices soar

A congressional bill seeks to increase the number of homes for sale by doubling the exclusions from capital gains tax.

Even a million dollars couldn’t persuade a Fountain Valley woman to sell her 40-year-old home, even though she’d prefer to downsize and be closer to her children and grandchildren.

It’s not because the family homestead has sentimental value. And it’s not because she still requires four bedrooms, two and a half bathrooms, and a large backyard.

“Why don’t I sell?” Sue, who lives alone, expressed concern about using her last name in print. “(A sale) leaves many homeowners, like me, with a huge capital gains tax.”

Capital gains, a term most commonly associated with investment property, has crept into the lexicon of suburban tract home residents.

Previously, most homeowners were exempt from paying taxes on their primary residences. For single taxpayers, the first $250,000 in value gains are exempt from taxation, while married couples filing joint returns are exempt from taxation up to $500,000 in gains.

However, rising home values exposed more people to the tax because exemptions had not changed in the previous 26 years.

According to Realtor data, when the exclusion was implemented in 1997, the national median house price was only $129,000 and $186,490 in California. In August, the national median had tripled to $407,100, while the California median had increased fivefold to $859,500.

Sue’s house, which she and her ex-husband purchased for $125,000 in 1983, is now worth approximately $1.1 million. Her accountant estimates that if she sold today, the capital gains tax would be at least $104,000.

“(If) I’m going to move … (it would be) with a lot less money to buy the next house,” she went on to say. “This is really a big problem and, if addressed, could solve a huge shortage of good family homes that are being underutilized by seniors.”

Some argue that the tax is more than offset by owners’ record profits on their homes.

However, a few lawmakers and at least one housing economist believe the capital gains tax is discouraging people from selling their homes. As a result, there is a significant shortage of available homes on the market. For-sale listings in Southern California, for example, are about one-third lower than usual.

A bill currently before Congress seeks to address this issue by doubling the amount of profit exempt from taxation.

The California Association of Realtors applauded the bill as a possible solution to the state’s housing shortage. In a separate analysis, CAR determined that the bill could protect two-thirds of homeowners who are currently subject to such a tax.

‘A simple fix’

The “More Homes on the Market Act” would raise the capital gains exclusion for single filers from $250,000 to $500,000. The exclusion for married couples filing jointly would increase from $500,000 to $1 million.

The bill, co-sponsored by Reps. Jimmy Panetta (D-Carmel Valley) and Mike Kelly (R-Pa.), would also index the exclusion to keep up with inflation.

“The existing exemption was created in 1997 and fails to take into account inflation and the sharp increase in home prices,” Panetta said in a written statement. “A simple fix would allow homeowners to downsize, sell their homes, and keep their nest-eggs intact while providing one solution that can help the affordable housing issue.”

The exemption, which was designed to protect homeowners rather than investors or flippers, can only be used for a primary residence that the owners have lived in for at least two of the last five years.

The bill has 27 bipartisan cosponsors, including Democratic Reps. Katie Porter and Ted Lieu and Republican Reps. Mike Garcia and Michelle Steel.

Because the bill has not yet been reported out of committee, the Congressional Budget Office has not conducted an analysis to determine how much doubling the exemption will cost the federal government.

An interesting problem

Most economists blame low for-sale inventory on high mortgage rates rather than the capital gains tax.

With interest rates up four percentage points in the last two years, most homeowners would rather stay in their current home than buy a new one, which would double their monthly mortgage payment.

“I think interest rates are the much bigger issue,” says Fred Mihaylo, a Coldwell Banker agent in Laguna Niguel. “I don’t believe people are not selling only because of capital gain.”

At the same time, homeowners benefit from a slew of government safeguards, ranging from the federal mortgage-interest tax deduction to Prop. 13 property tax limits in California.

According to Mission Viejo accountant Mark LeWinter, the cost of the tax is more than offset by the profits homeowners receive.

“Of all the problems to have in this world, this is a good one,” LeWinter went on to say. “I’m aware that the California Association of Realtors would like to sell more properties, but when (homeowners) pay a tax, it’s not the end of the world.”

However, Jordan Levine, chief economist for the California Association of Realtors, disagrees. He believes that the capital gains tax is responsible for a significant portion of the homes that are being withheld from the market.

CAR calculated that if 2.7 million California homeowners sold today, they would have to pay capital gains tax. If the bill is passed and exemptions are doubled, that number will fall to just over one million.

If only 5% of those homes were to sell, the statewide market would gain approximately 85,000 listings.

“Even a small fraction of those units coming onto the market would result in a significant number of new listings,” Levine said in a statement.

Levine observed that those subject to capital gains tax are most often long-term owners with paid-off mortgages. That means they can pay cash for their next home and avoid the high mortgage rates of today.

Barbara, a single senior who did not want her last name used, would have to pay up to $130,000 in capital gains taxes if she sold her four-bedroom Orange home. She drained her pool because no one was using it and it was too expensive to maintain. The upkeep on her 10,000-square-foot lot is also a burden.

“I would consider (selling) if I weren’t looking at capital gains,” she said.

Instead, she is considering relocating and renting out the house. She’d be able to sell the house after two years, transfer the gain to a new rental property, and defer the tax.

Barbara clarified that the tax would not impoverish her.

“It’s more of a question of what is a financially prudent decision?” Is it better to sell and pay the capital gains tax, or should you rent?”

Sue, the Fountain Valley homeowner, noted that when the current capital gains exclusions were implemented in 1997, median home prices were significantly lower than the $250,000 threshold.

“People assumed it was only for the wealthy.” “And now you have middle-class people paying that,” she said, noting that median house prices in Orange County now exceed $1.2 million.

“You know, (my house) is a fantastic place to raise a family. Excellent schools, a park around the corner, and a lovely backyard. “However, it is underutilized,” she stated. “So, if you’re going to penalize me to move, I might just stay.”