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Doubling the Residential Exclusion Amount is a Win-Win

Since 1998, you can sell your home and exclude gain from your income of up to $250,000 (single filing) and up to $500,000 (married filing joint). But with inflation, shouldn't that excludable amount be increased? Here's an idea that would benefit individuals and the government.

By Robert Klein, CPA

For the past 24 years, you have been able to sell your principal residence and exclude gain of up to $250,000 if using single filing status and up to $500,000 if married filing joint. The home-sale exclusion rule applies if the property has been owned and used as your principal residence for two or more years during the five-year period ending on the date of sale. The exclusion is generally allowed no more frequently than once every two years.

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. The firm’s motto is Planning, Managing, and Protecting Your Retirement Income™. Bob is the creator of FINANCIALLY InKLEIN’d™, a YouTube channel featuring tax-sensitive, innovative strategies for optimizing retirement income. Bob is also the writer and publisher of Retirement Income Visions™, a blog featuring innovative strategies for creating and optimizing retirement income that Bob began in 2009.

Robert Klein

Although the home-sale exclusion was a welcome change when it became effective in 1998, it has failed to keep pace with housing price inflation. According to the U.S. Bureau of Labor Statistics, the inflation rate for housing from 1998 to March 2022 averaged 2.53% per year. Housing prices are 81.94% higher in March, 2022 than 1998. Applying this to the home-sale exclusion, the housing price inflation-adjusted amounts should be $455,000 and $910,000, respectively.

Epic Housing Shortage

Inflation began noticeably worsening when annual rates increased from 2.6% in March 2021, to 4.2% in April with steady increases to a new four-decade high of 8.5% in March 2022. Housing prices have soared, increasing nationwide from 18.5% in December 2021, compared to December 2020. This has resulted in an epic housing shortage and associated buying frenzy with no end in sight for the short term.

We know that higher mortgage rates and increased housing inventory, along with the fact that home price growth can’t outpace income growth forever, will cause the buying frenzy to end. High real estate taxes, higher mortgage rates, and other increasing costs of homeownership will make ongoing affordability more difficult for recent homebuyers.

Reduced housing inventory without some form of stimulus is more problematic given the origin of the current housing shortage. The forces driving the housing market frenzy according to Tom Brady’s January 26, 2022, Mynd report article include “a flight from urban centers by pandemic-weary apartment dwellers looking for more space, a construction industry that has been underbuilt for the past decade, and developers who are coping with lumber prices that have skyrocketed in the last year, and increases in the costs of materials like steel, drywall and other building materials.”

Double Home-Sale Exclusion to Increase Existing Housing Inventory

The foregoing factors have created a perfect storm for Congress to enact legislation to double the home-sale exclusion amounts of $250,000 (single) and $500,000 (married filing joint) to $500,000 and $1 million, respectively. Ignoring the dramatic increase in inflation over the past 13 months that isn’t expected to subside any time soon, as previously stated, the home-sale exclusion should be $455,000 and $910,000, respectively, if simply adjusted for housing inflation over the last 24 years.

A doubling of the home-sale exclusion would increase existing housing inventory since it would motivate homeowners with highly-appreciated homes who want to sell but have been reluctant to do so due to the low home-sale exclusion amount. This includes older homeowners with substantial unrealized appreciation. Many of these individuals are averse to selling their homes given the fact that their heirs will be able to do so with much less or no income tax liability using the step-up in basis rules at death.


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Doubling of Home-Sale Exclusion Would Increase Tax Revenue

In addition to reducing the existing housing shortage, a doubling of the home-sale exclusion would stimulate sales of highly-appreciated properties. The unrealized gains on many of these properties significantly exceed the proposed increased home-exclusion amount. This would translate to a sizable increase in federal and state income tax revenue.

An obvious question is what about the potential loss of tax revenue from the increased home-sale exclusion amounts? Given the amount of wealth tied up in unrealized housing gains, I believe that the total additional revenue from income tax liability attributable to taxable capital gains from the sale of primary residences that wouldn’t otherwise occur will far exceed reduced revenue attributable to the increased exclusion.

Make Legislation Retroactive to Proposal Date

It behooves Congress to make the legislation retroactive to its proposal date given the length of time from proposal to enactment of this type of legislation. Doing so would kick-start the housing shortage reduction, increase tax revenue sooner, provide a stimulus for the overall economy, and present a public relations opportunity for a much-beleaguered and divided Congress in recent years. This would be especially welcome given the administration’s proposal to double the long-term capital gains tax rate of 20% to 39.6% for households with income over $1 million a year ago.

Conclusion

The doubling of the residential exclusion amount from $250,000 for single filers and $500,000 for joint filers to $500,000 and $1 million, respectively, is a win-win situation. It would increase tax revenue while reducing the existing housing shortage and accelerate the elimination of the current buying frenzy. This would, in turn, stabilize housing prices, reduce inflation, and make residential properties more affordable. Finally, it would make homeowners less dependent on home equity lines of credit and reverse mortgages since housing wealth would be freed up.

About the author: Robert Klein

Robert Klein, CPA, PFS, CFP®, RICP®, CLTC® is the founder and president of Retirement Income Center in Newport Beach, California. The firm’s motto is Planning, Managing, and Protecting Your Retirement Income™. Bob is the creator of FINANCIALLY InKLEIN’d™, a YouTube channel featuring tax-sensitive, innovative strategies for optimizing retirement income. Bob is also the writer and publisher of Retirement Income Visions™, a blog featuring innovative strategies for creating and optimizing retirement income that Bob began in 2009.

Bob applies his unique background, experience, expertise, and specialization in tax-sensitive retirement income planning strategies, including fixed income annuities, Roth IRA conversions, HECM reverse mortgages, and charitable remainder trusts, to optimize the projected longevity of his clients’ after-tax retirement income and assets. Bob does this as an independent financial advisor using customized holistic planning solutions determined by each client’s financial needs.