Taxing Our Way into a Housing Shortage
The elusiveness of affordable homes has metastasized into a chronic affliction of our political life. It hobbled Joe Biden’s presidency and now burdens Donald Trump’s. The administration is even weighing a declaration of a National Housing Emergency.
If that declaration is to mean anything, it should begin not with subsidies or gimmicks, but with a simple fix: knock out the tax burden that is keeping many older Americans locked in their homes and younger American families locked out.
Under current law, a couple selling their home for more than they bought it for is taxed on the capital gain once it exceeds $500,000. With home prices having surged in recent decades, that tax bill is no longer rare. According to housing policy analysts, roughly a third of homeowners now face federal tax liability if they sell, and six million Americans over 65 are living in homes more than twice the national average size.
The result is that millions of American homes are basically locked out of the market by the taxman. This means that the supply is artificially constrained in a way that has a perverse regressive effect. Current owners of bigger homes are stuck, which means that younger couples in starter homes cannot buy a bigger home as their family expands, which in turn means that a young couple in an apartment can’t get a starter home.
This situation is not the result of a market failure or a law of economics. It’s a policy failure. We could address it by simply letting more seniors sell their homes without paying capital gains taxes.
An op-ed published in the Washington Post this week makes the case for a capital gains tax cut to break up the housing logjam. Fascinatingly, this idea did not emerge from the libertarians at the Cato Institute or the folks at the Heritage Foundation. The author is Jim Parrott, a veteran housing policy analyst who worked in the Obama White House’s economic team.
A Clinton-Era Relic Weighs on Housing
Congress set the home-sale capital-gains exclusion at $250,000 for single filers and $500,000 for married couples nearly three decades ago. At the time, lawmakers didn’t intend to saddle older homeowners with heavy tax costs. Few sales resulted in federal liability. But the amounts were never indexed to inflation or to home prices. After a generation of appreciation, that 1997 relic now ensnares ordinary middle-class owners.
Parrott runs the math. A single filer in Raleigh who bought a median-priced home for $125,000 in 2000 could sell today for about $450,000. The $325,000 gain leaves a $15,000 federal bill. In Denver, the tax is closer to $40,000. In Seattle, nearly $70,000. Roughly a third of all homeowners would owe the IRS if they sold. So they don’t. They wait to die, at which point heirs inherit with a stepped-up basis. This is rational for their families, but disastrous for the housing market.
No Subsidy Required
Parrott’s proposal is straightforward. Raise the exclusion for seniors—say, to $500,000 for singles and $1 million for couples—or extend it to anyone who has owned their home for a decade. Then index it going forward so that we don’t repeat the 1997 mistake. This change doesn’t hand out subsidies or juice demand. It simply removes a penalty that locks up supply. Seniors can downsize without cutting a check to Washington. Families can move up. Renters finally get a crack at starter homes. Everyone climbs a rung.
We could go even further by eliminating capital gains on home sales altogether. That would almost certainly unleash more selling. But it would also be far costlier in budget terms and would be unlikely to win bipartisan support. It also risks diverting too much capital into housing and home flipping by creating too broad of an exclusion. We don’t want to replace a housing shortage with a housing investment bubble. Parrott’s version is the middle course—targeted enough to be fiscally manageable, but big enough to shake loose the locked inventory that is gumming up the housing market.
And note: the Federal Reserve’s stumbles toward lower rates won’t solve this. Seniors with decades of equity are not constrained by mortgage costs; they are constrained by tax liability. The binding constraint is fiscal, not monetary.
If It Works, It Adds to Housing Supply. If Not, It’s Free
The cost? Parrott estimates no more than $6 billion a year. Contrast that with the $50 billion in GDP Moody’s says we lose annually from reduced labor mobility. Better yet, the policy is fiscally asymmetric. If owners don’t sell, there’s no exclusion to claim and virtually no revenue lost. If they do, states collect transfer and property taxes, brokers and contractors earn taxable income, and productivity rises. It is as close to a no-regrets policy as Washington is capable of producing.
The Trump administration might embrace this targeted fix as a keystone to its attempt to repair the housing market. It is cheaper, more disciplined, and harder to caricature as a giveaway to the rich than many of the other proposals floating around Washington. Ironically, a former Obama administration official is playing the role of the herald of conservative housing reform that actually expands supply.
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