Surging home prices trigger capital gains tax for more middle-class homeowners

Soaring housing prices have pushed a growing number of home sellers to a place they never thought they’d be: owing capital gains tax.

With more home sales topping $500,000 in profits for sellers, triggering a first-time tax liability, it’s not just those who are unloading palatial estates who are being hit with the added costs.

“In New York, in California, in other high-cost markets, a million-dollar home is really not a fancy home these days. So, really, I think you are looking at homeowners who are just middle-class. Average-income homeowners … may notice that they may end up owning capital gains tax,” said Yanling Mayer, principal economist at CoreLogic, an Irvine, California-based provider of analysis on the real estate industry

Last year, 229,600, or 7.9%, of existing-home sales required capital gains tax payments, a 150% increase over the average from 2017 to 2019, according to a CoreLogic report authored by Mayer. The peak was hit in 2022 during the COVID-19 pandemic, when 304,100, or  8.1%, of existing-home sales qualified for capital gains tax payments. (These are gross capital gains that don’t take into account whether homeowners took any deductions to lower their tax liabilities.)

Capital gains tax is assessed on profit from the sale of an asset.

The gains are calculated by subtracting what was initially paid for a house from the later selling price. 

If the home was a primary residence for at least two of five years, exemptions can be taken.  The exemption limit is up to $500,000 for a married couple filing a tax return jointly or up to $250,000 for a single person. Those limits were set by the Taxpayer Relief Act of 1997. 

But capital gains exemptions have lagged behind inflation and the rising cost of living since 1997, Mayer said.

In 1997, only 1.3% of existing-home sales had gross capital gains that exceeded the exemption limits, according to CoreLogic.

Deductions for the cost of major home improvements, such as remodeling a kitchen or landscaping, can be applied to capital gains to reduce the tax burden.

For example, if a married couple bought a house for $200,000 in 1980, and then sold that house for $800,000 in 2023, the difference is $600,000. They can deduct the $500,000 exemption and the $15,000 cost of a kitchen remodel they did in 2003, leaving them with a capital gain of $85,000 that will be added to their taxable income.

They’ll be taxed at 0%, 15% or 20%, depending on their income bracket.

Long-term homeowners selling their houses in high-cost areas are being hit the hardest.

Nationwide in 2023, California had the highest percentage of existing-home sales, 28.8%, that had gross capital gains above $500,000, according to CoreLogic. Hawaii ranked second, with 23.8%, followed by Washington, D.C., 22.1%; Massachusetts, 17.9%; Washington State, 15.2%; and New York, 13.1%.

Because the costs of home improvements can significantly reduce capital gains, it’s important for homeowners to keep records of the work, regardless of when it took place, said Mary Kay Foss, a certified public accountant in Walnut Creek, Calif.

“People tend to forget all of the money they spent to improve their house over the years,” said Foss, who is also vice chair of the Individual and Self-employed Tax Committee with the American Institute of Certified Public Accountants, which is based in Durham, N.C.” With the big prices today, people are going to have to do a lot more work to be sure they’ve captured all of the expenses.”