It might seem antithetical that high equity would be a problem for homeowners until you dig a bit deeper. For the last several years many potential sellers wanting to sell have not done so because of the “golden handcuffs” of two to three percent interest rates. But due to life circumstances a number of sellers can no longer wait and must now sell. Meanwhile many buyers are stuck on the sidelines by unaffordable home prices, high interest rates, and skyrocketing insurance expenses. This despite recent findings that inventory is at an all time high and the number of sellers has now outnumbered buyers. But there is another set of handcuffs you and your sellers should be aware of and they are far from golden. Here’s more on the problem with high equity homeownership:
CAPITAL GAINS
The crux of the matter stems from the way we handle capital gains from home sales. It all goes back to the Taxpayer Relief Act of 1997 when Congress rewrote the rules for taxing homeowners’ profits from selling a primary residence. Prior to that the process was a complicated maze of rules and paperwork. Here are today’s rules:
- You can sell your primary residence and be exempt from capital gains taxes on the first $250,000 if you are single and $500,000 if married filing jointly.
- This exemption is only allowable once every two years
- The home must be your principal residence.
- You can add your cost basis and costs of any improvements that you made to the home to the $250,000 if single or $500,000 if married filing jointly.
YES, BUT WHAT ABOUT INFLATION?
One huge component of the rules for today’s capital gains was overlooked: Inflation. Back in 1997 $250K and $500K were usually enough to get most sellers off the hook for capital gains, but now twenty-eight years later, it is often far from enough. It’s estimated that 1 in 3 homeowners nationwide is already at risk of a surprise capital gains bill and those hit hardest are the owners who’ve stayed put the longest, especially in areas that have seen explosive price appreciation.
It’s unfortunate that this dynamic is especially dramatic in the most competitive areas that need relief the most. Potential sellers in these areas are sitting on equity that they will pay a steep price to unlock, so many are choosing to stay put, further paralyzing the housing market. Because inflation was not accounted for when the law was created its effects are increasingly hitting the middle class and older homeowners. Sadly, it’s keeping many older homeowners from tapping into their equity for more comfortable aging and care. Additionally, some older homeowners are reluctant to sell because they know that the “stepped up” pricing on their home once they pass will give their heirs a smaller tax burden.
SURGING PROPERTY TAXES
If the fear of five or six figures owed in capital gains doesn’t scare sellers, consider today’s surging property taxes. Many older homeowners now face property taxes that are more than their mortgage. This is a scary reality when you are living on a fixed income. But those who would like to sell and live in a lower property tax environment often feel stuck between a rock and a hard place. Continue to pay exorbitant property taxes or sell and get hit with enormous capital gains? Middle class folks who played by the rules, stayed in one place and built up equity over a lifetime of productive work are now being charged a substantial fee for having done so. The rich reward they thought they could count on–namely their home equity–has become a penalty. And as more of those homes stay off the market, younger buyers are prevented from tapping into the American Dream of homeownership.
THE SOLUTION
It’s clear that the Taxpayer Relief Act of 1997 needs an update. Obviously it must account for inflation for a start. Such a thing was proposed in 2023 and called the “More Homes on the Market Act.” It aims to double the exemptions to $500K for individuals and $1 million for couples in order to account for 28 years of inflation. However, at the moment it is lost in limbo-land as it waits for congressional approval. Awareness is key and understanding what your sellers are up against will help the collaborative process when it comes to listing their home. Staying informed about the Act’s progress is crucial. Its potential impact could reshape the housing market, influencing your selling strategy. And as always when it comes to anything tax related, sellers should obtain professional direction from a qualified tax professional.