Capital Gains Taxes Box Home Sellers Into a Corner—These States Are the Hardest Hit

Home values have risen rapidly over the past few years, but when it comes time to sell, that windfall can come with a nasty surprise: capital gains taxes.

Since 1997, home sales that generated less than $500,000 in profits for the seller have typically been exempt from federal taxes on capital gains, which are the same kind of taxes levied on profits from the sale of stocks and other assets.

For decades, few homes appreciated enough in value between purchase and sale to exceed the half-million dollar exemption cap. But a recent report from CoreLogic found that last year, 229,600 homes sold in the U.S., or 7.9% of all transactions, had gross capital gains above $500,000, potentially triggering tax liability. That’s up from an annual share of 1.3% 20 years ago.

In some areas, capital gains taxes on home sales are now becoming common enough to push many potential sellers to the sidelines, says Anne Russell, director of risk management at Rodeo Realty of Beverly Hills, CA.

“With all of these exorbitant capital gains tax events for sales, many, many older Americans now are not selling, because too much of that money will go to taxation, and not enough to their heirs,” says Russell. “Instead they’re aging in place.”

Due to a quirk in tax laws, it might make sense for certain homeowners to cling to their current homes until death, at least under the current rules. That’s because when a property is inherited, the cost basis of the home, which would otherwise be the original purchase price, resets at current market value for whoever inherits it.

The difference between cost basis and sale price is the “capital gain,” or profit, subject to federal taxes if it exceeds $500,000 for a home.

For example, if a home was purchased years ago for $700,000 and is now worth $1.2 million, selling it could trigger capital gains taxes for the homeowner, which range as high as 20% depending on the tax bracket. But, even if the home’s value continues to rise during the original homeowner’s lifetime, the heirs could potentially sell it tax-free after the owner dies.

Why are more homeowners paying capital gains?

One major reason for the increasing frequency of tax hits on home sales is that the exemption limit has not been adjusted for inflation since 1997, when it was set at $250,000 for single filers and $500,000 for couples filing jointly. When indexed for inflation, $500,000 in 1997 dollars would be worth about $985,000 today, nearly double the threshold originally set by Congress.

In Congress, recently proposed legislation known as the More Homes on the Market Act would raise the capital gains exemption limit on homes, and automatically raise the cap in response to future inflation.

Introduced in March 2023 by U.S. Rep. Jimmy Panetta, a Democrat from California, the bill has gained bipartisan support, with 16 Republicans and 35 Democrats signed on as co-sponsors.

"There are many people who want to sell their homes but won’t due to the hit they’ll take on taxes," Panetta tells Realtor.com. "The result is, fewer people putting their homes on the real estate market can create housing shortages and housing affordability issues."

Pannetta's bill would increase the capital gains exclusion limit on homes to $500,000 for single filers and $1 million for joint filers, and regularly increase the limit in the future to keep pace with inflation. That would be in line with other tax provisions that change to reflect inflation, such as the standard deduction or income tax credit.

Backers of the bill say that incentivizing older, empty-nest homeowners to sell would allow young families to trade up from their starter homes, freeing up housing stock across all price ranges.

"I firmly believe that such a simple, straightforward fix would allow homeowners to downsize, sell their homes, and secure their nest eggs," says Panetta, whose district includes parts of high-priced San Jose. "It’s also a common-sense way to help expand the housing market, tackle housing affordability issues in our communities, and better ensure that more families have access to owning a home."

U.S. Rep. Mike Kelly, a Pennsylvania Republican, joined Panetta as the initial co-sponsor of the bill, underscoring the bipartisan appeal of the tax reform.

"As housing prices have increased, people who have chosen to downsize have been unfairly punished with massive tax burdens," Kelly said when the bill was introduced last year. "After years of making improvements and investments into their homes, which is the largest purchase for most Americans, homeowners deserve to keep more of their hard-earned money during their golden years."

However, despite bipartisan support and backing from the National Association of Realtors®, the bill has remained in committee since it was introduced. It is unclear when it might reach a floor vote in the Republican-controlled House, with one Democratic staffer telling Realtor.com that the prospects of passing the bill in the current session look "pretty dim."

Where are taxes on home sales most common?

According to the CoreLogic report, in the fourth quarter of last year, 28.8% of all home sales in California were potentially subject to capital gains taxes. That's up from an average rate of 13.2% in the state from 2017 to 2019.

Following California, the places with the highest share of home sales with appreciation over the $500,000 limit at the end of 2023 were Hawaii (23.8%), Washington, DC (22.1%), Massachusetts (17.9%), and Washington state (15.2%).

As well, New York, Colorado, and New Jersey all had double-digit shares of home sales that could face capital gains taxes.

"At the state level, long-term homeowners in high-cost areas are expected to carry the lion’s share of homes that owe significant capital gains payments," wrote CoreLogic economist Yanling Mayer. "That is because in dollar terms, high prices equal higher amounts of capital gains if given the same rate of home price growth, not to mention that many high-priced areas are frequently among the fastest-appreciating markets."A