Personal Finance

Some home sellers would see huge savings under Treasury tax cut plan

Key Points
  • The Treasury Department is exploring whether it can bypass congressional approval to index long-term capital gains to inflation.
  • Such a change would lower the amount of tax that people pay when they sell certain assets, such as stocks and real estate.
  • While you can exclude up to $250,000 ($500,000 for married couples) in gains on a house from taxation, those amounts have not been adjusted for inflation since their inception more than two decades ago.

Homeowners who face a big tax bill when they sell their house could emerge as beneficiaries of a Trump administration plan to change how investment gains are taxed.

Breathing new life into an idea that has been around for several decades, the Treasury Department is studying whether it can bypass congressional approval to index long-term capital gains to inflation.

In simple terms, this would mean the appreciation in an asset's price that could be attributed to inflation would not be taxed. The change would cost an estimated $102 billion over 10 years, according to a Penn Wharton analysis done in the spring. It also would largely benefit the wealthiest of American households.

Secretary of the Treasury Steven Mnuchin testifies to the House Financial Services hearing on state of the international financial system on Capitol Hill in Washington, July 12, 2018. 
Joshua Roberts | Reuters

Nevertheless, homeowners whose houses have surged in value over the years could benefit from such a tax cut whether they are wealthy or not.

"To some people, it might sound like a giveaway to the rich," said certified financial planner David Rae, president and founder of DRM Wealth Management in Los Angeles. "But here in Los Angeles and in some other places, a lot of homes that are worth $800,000 or $900,000 originally were bought for $100,000 or less several decades ago."

While the national median price of homes sold is $231,700, according to Zillow, some hot markets come with much higher housing costs. For example, in California, that figure is about $603,000. In Washington, D.C., it's $535,500, and in New York, $568,300.

Existing law already allows owners to exclude $250,000 (for singles) or $500,000 (for married couples) from capital gains taxation when the house is sold. However, it's easier to exceed those amounts in high-cost areas.

What you pay on long-term capital gains

Tax rate Single taxpayers Married filing jointly Head of household
0%Up to $38,600Up to $77,200Up to $51,700
20%Over $425,800Over $479,000Over $452,400
Extra 3.8%Over $200,000Over $250,000Over $200,000

For illustration purposes: Say that in 2000, a single person in California paid $211,500 — the median price in that state at the turn of the century — for a house. In 2018, say it sells for the current median price of $603,000. Under current rules, the gain would be $391,500.

After subtracting the $250,000 exclusion available to a single person, the seller would pay taxes on the remaining $141,500 gain. At the highest rate — 20 percent — that would mean a tax bill of $28,300.

In contrast, if a portion of the $391,500 gain were attributed to inflation since 2000, the taxable share would be much lower.

Home Sales Declining in Southern California
Home Sales Declining in California

In this example, about $104,000 of the sale price would be due to inflation, according to a Bureau of Labor Statistics calculator. Subtracting that amount from the $391,500 gain would leave $287,500. After the $250,000 exclusion, the remaining $37,500 would generate a tax bill of $7,500 — $20,800 less than under current law.

Part of the existing problem, say experts, is that the exclusion amounts have not changed since they were established in the 1997 Taxpayer Relief Act.

"In 1997, $250,000 and $500,000 seemed like an impossible amount of gain to have on the sale of a house for almost everybody," said Evan Liddiard, senior policy representative at the National Association of Realtors.

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There's also the chance that down the road, tax bills for home sales could become more widespread.

"Within another decade or two, there will be a lot of home sales throughout America that have gains above the exclusion," Liddiard said. "Inflation will push home prices up, and the exclusions are not adjusted for inflation."

If those exclusions had been adjusted annually since 1997, they'd now be at about $396,000 for singles and $792,000 for married couples.