Amid booming home prices, capital gains tax is crimping inventory, lawmakers say

A million dollars couldn’t entice a Fountain Valley woman to sell her house of 40 years even though she’d rather down-size and move closer to her children and grandchildren.

It’s not because of the sentimental value of the family homestead. And it’s not because she still needs four bedrooms, 2 ½ bathrooms and a big backyard.

“Why don’t I sell?” said Sue, who lives alone and doesn’t feel safe using her last name in print. “(A sale) leaves many homeowners, like me, with a huge capital gains tax.”

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Capital gains — a term most commonly associated with investment property — has seeped into the vocabulary of residents living in long-held suburban tract homes.

In the past, most homeowners were sheltered from the tax on their primary residences. The first $250,000 in value gains are excluded from the tax for single taxpayers while $500,000 in gains are excluded for married couples filing joint returns.

But skyrocketing home values exposed more people to the tax because the exemptions haven’t changed in the past 26 years.

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When the exclusion was adopted in 1997, the median house price was just $129,000 nationwide and $186,490 in California, Realtor figures show. As of August, the U.S. median had tripled to $407,100, and the California median jumped five-fold to $859,500.

In Sue’s case, the house she and her ex-husband bought for $125,000 in 1983 is now worth about $1.1 million. If she were to sell today, her accountant estimates, the capital gains tax would be at least $104,000.

“(If) I’m going to move … (it would be) with a lot less money to buy the next house,” she said. “This is really a big problem and, if addressed, could solve a huge shortage of good family homes that are being underutilized by seniors.”

Some argue that the tax is more than offset by soaring profits owners made on their homes.

But a handful of lawmakers and at least one housing economist believe the capital gains tax is discouraging people from selling. That, in turn, is contributing to a major shortfall in the number of homes on the market. In Southern California, for example, for-sale listings are running about a third below normal.

A bill pending in Congress seeks to remedy that problem by doubling the amount of profit that’s exempt from the tax.

The California Association of Realtors hailed the bill as a possible solution to the lack of housing. In a separate analysis, CAR determined the bill could shield two-thirds of homeowners now exposed to such a tax.

‘A simple fix’

Called the “More Homes on the Market Act,” the measure would increase the capital gains exclusion from $250,000 to $500,000 for single filers. For married couples filing a joint return, the exclusion would go from $500,000 to $1 million.

The bill, co-authored by Rep. Jimmy Panetta, D-Carmel Valley, and Rep. Mike Kelly, R-Pa., would also index the exclusion so it keeps pace with inflation.

“The existing exemption was created in 1997 and fails to take into account inflation and the sharp increase in home prices,” Panetta said in a statement. “A simple fix would allow homeowners to downsize, sell their homes, and keep their nest-eggs intact while providing one solution that can help the affordable housing issue.”

Designed to protect homeowners rather than investors or flippers, the exemption can only be used for a primary residence that owners have lived in for at least two of the last five years.

The bill has drawn support from 27 co-sponsors from both parties, including Democratic Reps. Katie Porter and Ted Lieu and GOP Reps. Mike Garcia and Michelle Steel.

Because the bill has yet to be reported out of committee, the Congressional Budget Office hasn’t done an analysis to determine how much a doubling the exemption will cost the U.S. Treasury.

Also see: Rising mortgage rates squeeze Southern California homebuyers, depress sales

A good problem

Most economists attribute low for-sale inventory to high mortgage rates, not the capital gains tax.

With rates up 4 percentage points in the last two years, most homeowners prefer to stay put in their current home than buy a new one that doubles their monthly house payment.

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“I think the interest rates are the much bigger issue,” said Fred Mihaylo, a Coldwell Banker agent in Laguna Niguel. “I don’t believe people are not selling only because of capital gain.”

At the same time, homeowners benefit from a wide array of government protections, ranging from the federal mortgage-interest tax deduction to California’s Prop. 13 property tax limits.

Mission Viejo accountant Mark LeWinter believes the cost of the tax is more than offset by the profits homeowners reap.

“Of all the problems to have in this world, this is a good one,” LeWinter said. “I’m aware that the California Association of Realtors would like to sell more properties, but when (homeowners) pay a tax, it’s not the end of the world.”

But Jordan Levine, chief economist for the California Association of Realtors, begs to differ. He believes the capital gains tax accounts for a significant portion of the homes being withheld from the market.

CAR calculated that just over 2.7 million California homeowners would be subject to paying a capital gains tax if they sold today. That number would drop to just over 1 million if the bill were to pass and exemptions were to double.

If just 5% of those homes were to go on sale, that could add about 85,000 listings to the statewide market.

“Even a small fraction of those units coming onto the market would result in a significant number of new listings,” Levine said.

Levine noted that those facing the capital gains tax most often are long-term owners with paid-off mortgages. That means they can pay cash for their next home without worrying about today’s high mortgage rates.

Barbara, another single senior who didn’t want her last name used, would have to pay as much as $130,000 in capital gains taxes were she to sell her four-bedroom house in Orange. She drained her pool because nobody’s using it and it cost too much to maintain. The upkeep on her 10,000-square-foot lot is a burden as well.

“I would consider (selling) if I weren’t looking at capital gains,” Barbara said.

Instead, she’s thinking of moving elsewhere and renting out the house. Then, after two years, she’d be able to sell the house, transfer the gain to a new rental property and defer the tax.

It’s not that the tax would impoverish her, Barbara added.

“It’s more of what is a financially wise decision? Is it financially wise to sell and pay the capital gains or should you do the rental?”

Sue, the Fountain Valley homeowner, noted that when the current capital gains exclusions were adopted in 1997, median home prices were well below the $250,000 threshold.

“People thought, that’s just for rich people. And now you have middle-class people paying that,” she said, noting that median house prices now top $1.2 million in Orange County.

“You know, (my house) is a great home for a family. Great schools, park around the corner, nice backyard. (But) it’s underutilized,” she said. “So, if you’re going to penalize me to move, I might just stay.”