A recent letter to the editor in the San Francisco Chronicle, highlighted by a tweet from Rohin Dhar, underscores how current capital gains tax exemptions can deter homeowners from selling their properties. The letter, penned by a California homeowner, articulates a willingness to sell a home that has become too large, provided the capital gains tax exemption for primary residences was more generous than the existing $500,000 threshold for married filers. This sentiment reflects a broader challenge in housing markets, particularly in high-value regions like California.
Federally, homeowners can exclude up to $250,000 of capital gains from the sale of their primary residence if single, or $500,000 if married filing jointly. To qualify, the homeowner must have owned and used the property as their primary residence for at least two of the five years preceding the sale. This exclusion, established in 1997, has not been adjusted for inflation, leading to a growing number of long-term homeowners exceeding these limits due to significant appreciation, especially in states with rapidly rising property values.
California largely conforms to these federal exclusion amounts for primary residence sales. However, any gain exceeding the federal exclusion is subject to California's state income tax rates, which can be as high as 13.3%, as capital gains are taxed as ordinary income in the state. This dual taxation at both federal and state levels significantly impacts the net proceeds for sellers with substantial gains, creating a disincentive to sell.
The financial implications of selling a highly appreciated home can create a "lock-in" effect, where homeowners, particularly older individuals or those who have lived in their homes for decades, opt to stay rather than incur a large tax liability. This phenomenon contributes to a constrained housing supply, especially in desirable areas, further exacerbating affordability issues for potential buyers. Real estate experts and economists have long pointed to this as a factor in low inventory.
Discussions around reforming capital gains tax on home sales have gained traction, with some proposals suggesting eliminating the tax entirely for primary residences or significantly increasing the exclusion limits. For instance, Rep. Marjorie Taylor Greene introduced the "No Tax on Home Sales Act," and former President Donald Trump has also voiced consideration for such a change. While proponents argue this could unlock inventory and stimulate the market, critics suggest it would disproportionately benefit wealthier homeowners and could potentially drive up home prices even further.