A tax rule from 1997 is increasingly catching wealthy homeowners off guard. The Taxpayer Relief Act of 1997 allowed married couples to exclude up to $500,000 in profit from the sale of a primary residence. Singles could exclude $250,000. Those thresholds were never indexed for inflation.
Today, the National Association of Realtors estimates 13.1 million owner-occupied households have unrealized gains exceeding those limits. That is 15% of all owner-occupied households. If home prices rise 30%, that number would nearly double to 27 million households.
Vulnerability varies dramatically by region. In California, 43.6% of homes exceed the limit. In Michigan, that number is just 5.5%. Single filers account for roughly 58% of exposed homeowners, often widowed or divorced individuals who have aged in place.
Critics argue raising the limit would primarily benefit high-income households. The Urban-Brookings Tax Policy Center notes that 95% of all households already owe no federal capital gains tax on a home sale. They say expanding the exclusion would do little to increase housing supply, which requires building more homes.
Proponents like Realtor.com economist Joel Berner argue the tax break was intended to unlock housing inventory, allowing empty-nesters to downsize without a tax penalty. Currently, a single filer who bought a home for $120,000 in 1996 and sells for $420,000 could face a taxable gain of $50,000. At a 15% federal capital gains rate, that adds roughly $7,500 in federal tax, plus potential state taxes.
Homeowners can reduce their taxable gain by accounting for major improvements like kitchen remodels or new HVAC systems, but routine maintenance does not count. Depreciation claimed from business or rental use also reduces the basis and increases gain. Taxpayers must also remember the two-year rule: you cannot claim the exclusion again within two years of the last sale.