Capital gains tax on home sales is why sellers owe taxes

A capital gains tax break for primary residence sales hasn’t kept pace with inflation and soaring home values, leaving a growing share of homeowners exposed. IRS rules allow up to $250,000 in gains for single filers and $500,000 for married couples, but thresh

The decision to sell a home can feel simple until the math shows up. For millions of Americans, the tax return isn’t just a formality—it’s the bill that comes due when they try to move, often after decades of living in the same place.

At the center of that tension is the capital gains tax on home sales. and a break that was built for a different housing era. The IRS allows homeowners to exclude up to $250. 000 of capital gains for a single filer and up to $500. 000 for married couples filing jointly on the sale of a principal residence—if they owned and used the home for at least two years out of the five-year period before the sale. But the exclusion threshold hasn’t been indexed to climb with inflation or rising home values.

That mismatch is now colliding with a housing market where prices have surged far beyond what lawmakers could have anticipated.

About 30 years ago, then-President Bill Clinton called for married couples to be able to keep up to $500,000 in profit from the sale of their principal residence tax-free. The idea won support across party lines and was included when Congress passed the Taxpayer Relief Act of 1997.

For a long time, the size of the exclusion made the tax issue easy to ignore. Joel Berner. senior economist for Realtor.com. said the risk of paying capital gains tax on a home sale isn’t widely understood because. for decades. the 1997 exclusion was large enough that many sales of primary residences didn’t trigger tax. “No one even talked about this issue for years,” Berner said.

The problem is that the threshold for the exemption hasn’t been adjusted upward. As home values rise, more homeowners can end up with gains that exceed the allowed limits, depending on the price appreciation in their community and their personal situation.

Nationally, the scale of what’s at stake is already visible. New research by the National Association of Realtors estimates that nationwide about 13.1 million homeowners—15% of all owner-occupied households—already have unrealized capital gains in their homes that exceed the limits allowed for the capital gains tax break.

In some states, the numbers are particularly striking. The study estimates 5.5% of homes exceed the limit in Michigan and 7.7% in Minnesota. In New Jersey, the share is 22.6%, and in California it is 43.6%, according to the study.

The outlook could worsen if home prices keep climbing. A 30% increase in home prices nationwide would effectively double the exposed homeowners to over 27 million households—or 31.3% of households nationwide in upcoming years. according to the study. The research also notes that since 1997, U.S. home prices have risen about three and a half times at the national level. and even faster in many metropolitan areas. Many communities saw serious price growth in 2021 and 2022 after demand surged following the start of the COVID-19 pandemic.

For some regions, the risk may still be lower; the study says that in a lot of Midwestern markets, the risk continues to remain fairly low.

Even so. many real estate professionals say the exemption should be reshaped—either by raising the limits or eliminating the capital gains tax on primary home sales entirely. They’ve argued for changes such as doubling the thresholds to $500. 000 for singles and $1 million for married couples. or removing the capital gains tax on primary residence sales.

Berner told the Detroit Free Press. part of the USA TODAY Network. that “It just unlocks the housing market.” He said it could allow more transactions and give people more flexibility to move up. Raising the limit. he added. could also provide older adults with more room to sell without worrying about a bigger income tax bill. “The people who are most penalized are people who have been in homes for a long time,” Berner said.

The worry is that the tax bill doesn’t just discourage selling—it can trap people in place. Berner said longtime homeowners are contending with maintenance costs and rising insurance. making it difficult for them to afford the big home. If they sell. he said. they can “get hit with this capital gains tax. ” which can push them to stay in place.

The push for higher or eliminated exclusions comes with pushback, too. Elena Patel. co-director of the Urban-Brookings Tax Policy Center and senior fellow. argued that under current law. most households still owe no capital gains tax on a primary residence sale. and expanding the exclusion would mainly benefit higher-income households.

Patel said raising the exclusion would “provide large benefits to a small group of high-income. high-wealth households. ” citing research from the Urban-Brookings Tax Policy Center. Her point is that under current law. 95% of all households—and 90% of households age 65 and older—would owe no federal capital gains tax on a home sale because their accrued gains fall below existing exclusion thresholds.

In Patel’s view. expanding the exclusion would therefore mainly offer additional tax benefits to a relatively small group of higher-income. higher-wealth households. while having limited effects on overall housing availability. She also said it would further increase tax preferences for households that already receive substantial housing-related tax benefits. including through the mortgage interest deduction.

The research also identifies who could be vulnerable if the tax exemption doesn’t match today’s home price reality. The study noted that many older homeowners who have aged in place following widowhood or divorce could face unexpected capital gains taxes on a home owned for many years.

Single filers account for roughly 58% of exposed homeowners, the report states. The study also points to homeowners who bought their houses before major price increases of the early 2000s and post-2012 period. California stands out for reasons of both scale and appreciation, the report said. But other large states—including Texas. Florida. and New York—also show sizable numbers of homeowners with gains above $250. 000 due to the size of their housing markets.

When people talk about the capital gains tax, a common misconception is what counts as taxable. Tom O’ Saben. director of tax content and government relations at the National Association of Tax Professionals. said one of the biggest misunderstandings is that homeowners think the entire gain becomes taxable once they exceed the exclusion amount. “That is not true,” he said.

Under the rules, a single filer can generally exclude up to $250,000 of gain, and married couples filing jointly can exclude up to $500,000 if other requirements are met. “Only the gain above those thresholds is potentially taxable, assuming they meet the other rules,” O’ Saben said.

There are also ways to reduce the taxable portion, including by increasing basis through qualifying costs. Mark Luscombe. principal analyst for Wolters Kluwer Tax & Accounting in Riverwoods. Illinois. said “Expenditures for home improvements can increase your basis in the home and. therefore. reduce your gain. ” and he stressed that the improvements need to qualify. He gave examples such as “a kitchen remodel. new additions or adding a new HVAC system. ” while saying regular upkeep costs like painting a bedroom don’t count.

Closing costs on the sale allocated to the seller can also reduce gain, Luscombe said. But he warned that any depreciation claimed over the years from business or rental use of the property may reduce basis and increase gain.

All of this matters because the federal tax rate on long-term capital gains for property held longer than one year is generally 0%. 15%. or 20%. depending on income. O’ Saben said. For many middle-income taxpayers. an extra $50. 000 of taxable long-term gain could create roughly about $7. 500 in federal tax at a 15% capital gains rate. In states that tax capital gains as ordinary income. the added cost can rise: O’ Saben said that in a state with a 5% income tax. that same $50. 000 of gain could add roughly another $2. 500 in state tax.

Eligibility rules can also quietly disqualify homeowners. The IRS rule cited here says a homeowner is generally not eligible for the exclusion if they excluded the gain from the sale of another home during the two-year period prior to the sale of their current home.

Luscombe said some unique situations can also trip people up. “Some people forget that you need to wait two years before claiming the exclusion again,” he said. He described an example involving marriage: if a couple marries and one spouse sells a home and moves in with the other. then they quickly start looking for a larger home and sell the other spouse’s home within the two-year period.

He also noted that gain associated with depreciation claimed on the home after May 6. 1997. from business or rental activity is not eligible for capital gains exclusion and may be taxed at a 25% capital gain rate. Luscombe said partial exclusions might be available in situations where the full “two out of five-year rule” is not met. He listed exceptions that can apply. including changes in employment. health reasons. or other unforeseen circumstances such as divorce. legal separation. multiple births from the same pregnancy. or natural destruction or condemnation of residence.

Across all of it, the core debate remains the same: should the exemption be widened to match housing prices, or should the focus shift elsewhere? Even advocates who want a higher limit acknowledge it won’t fix every issue tied to limited home supply.

Berner said the biggest piece is building more homes, adding that “Anything that encourages builders to deliver inventory is really the ultimate solution.” He said the country should have about 4 million more homes in the United States—or an increase of about 5%—to match the number of households.

For the homeowners already sitting on gains, though, the decision to sell can hinge on something far more immediate than new construction. The thresholds may be decades old, but the tax consequences are real—arriving the moment a move becomes more than a dream and turns into a sale.

capital gains tax home sale taxes IRS rules primary residence exclusion housing market Realtor.com National Association of Realtors tax policy Urban-Brookings Tax Policy Center