Fear surrounds the concealed property value levy hidden in home equity
In the ever-changing real estate market, homeowners are facing an increasing challenge: capital gains taxes on home sales. The reason? The federal exclusion limits for capital gains tax, set at $250,000 for singles and $500,000 for married couples, have remained unchanged since 1997, while home values have surged significantly.
This situation means that an increasing number of sellers are exceeding those exclusion thresholds and incurring capital gains taxes on the profit above the limits. In 2025, federal capital gains tax rates will remain between 0% to 20% based on income, with several states like Missouri continuing to apply their own rules.
New York, New Jersey, and California, for instance, have some of the highest state capital gains levies, ranging from 2.5% to over 10%. This can lead to a major loss of revenue at both the federal and state levels, potentially impacting the budget deficit or funding available for resources like public schools.
However, there is active legislative interest in reducing or eliminating capital gains taxes on home sales. Proposals like Rep. Marjorie Taylor Greene’s "No Tax on Home Sales Act" aim to eliminate federal capital gains tax on primary residence sales entirely. Other tax reforms are being considered to modernize the outdated rules affecting home equity, including proposals to raise exclusion limits or remove capital gains tax altogether to address the growing tax burden on average homeowners amid rising home equity stakes.
But it's not just about taxes. Some homeowners access home equity through sharing agreements with investors, selling a portion of future home appreciation. While this provides immediate cash without traditional loans, it can be costly if home values rise significantly, as investors claim a share of the appreciation, and upfront fees can be substantial. Such arrangements do not provide capital gains tax relief but rather represent a tradeoff of future equity, which may complicate homeowners' financial outcomes when selling the home later.
So, what can homeowners do? Keeping records and documents related to significant upgrades, like a new roof, kitchen remodel, or modernized HVAC system, can help homeowners add these costs to their home’s cost basis, lowering their taxable gain. Timing the sale of a home wisely, such as living in the home for two out of the last five years to qualify for the full exclusion or selling after marriage to double the exclusion, can also help homeowners avoid or reduce capital gains taxes.
It's crucial for homeowners to monitor tax law developments closely and consider the costs and benefits of equity extraction approaches in the context of potential capital gains tax liabilities. The National Association of Realtors warns that approximately 29 million households are at risk of incurring a capital gains tax on their home sales due to the rise in home equity stakes and unchanged exemption limits.
In summary, more homeowners are expected to face capital gains taxes due to rising home equity outpacing unchanged exclusion limits. However, legislative efforts are underway to reform or eliminate these taxes. Homeowners should stay informed and seek professional advice when making decisions about their homes and finances.
[1] National Association of Realtors. (2021). 2021 Profile of Home Buyers and Sellers. Retrieved from https://www.nar.realtor/content/dam/realtor/products-and-services/research/reports/2021-profile-of-home-buyers-and-sellers/2021-Profile-of-Home-Buyers-and-Sellers.pdf
[2] National Association of Realtors. (2021). Home Equity Sharing: What You Need to Know. Retrieved from https://www.realtor.com/advice/home-improvement/home-equity-sharing/
[3] Congressional Research Service. (2021). Capital Gains Taxation of Home Sales. Retrieved from https://crsreports.congress.gov/product/pdf/R/R46337
[4] IRS. (2021). Sale of Your Home. Retrieved from https://www.irs.gov/taxtopics/tc701
[5] Joint Committee on Taxation. (2021). General Explanation of the Administration's Fiscal Year 2022 Revenue Proposals. Retrieved from https://www.jct.gov/publications.html?func=startdown&id=5090
- To manage their personal-finance situation and avoid potential capital gains taxes, homeowners may consider keeping records of significant home improvements for increasing their home's cost basis, thus lowering their taxable gain.
- Proposals to modernize home equity rules in personal-finance reforms, such as raising exclusion limits or eliminating capital gains tax altogether, are being considered to help average homeowners who are at risk of exceeding the current exclusion thresholds and facing more capital gains taxes due to the rise in home equity stakes.
