June 26, 2025
The Hidden Home Equity Tax Straining Families For Staying In House Too Long
According to Realtor, roughly 1-in-3 homeowners—approximately 29 million households—have built up more home equity than the federal capital gains tax exclusion protects when people sell their primary home.
Home equity has long been viewed as a safety net for homeowners. Many families consider it a nest egg for future college expenses, inheritance for their children, or long-term care later in life. However, this once financial safety net is changing. Millions of American homeowners face a hidden tax burden they didn’t anticipate due to an outdated federal rule.
According to Realtor, roughly 1 in 3 homeowners—approximately 29 million households—have built up more home equity than the federal capital gains tax exclusion protects when people sell their primary residence. Single filers can exclude up to $250,000 in profit. Married homeowners, or those who file jointly, can exclude up to $500,000. These exclusions are the result of a 1997 federal rule change that fixed headaches for homeowners. Before Congress wrote the rule change, sellers could defer paying capital gains taxes if they purchased a more expensive home. However, they had to keep decades of receipts and were hit with taxes if they wanted to downsize.
“It was a compliance mess,” said Evan Liddiard, the NAR’s director of tax policy. “You had to keep track of the first home that you bought and every improvement in every home over the course of a lifetime to show how much gain you ultimately had.”
The rule change made things simple and opened the door for homeowners to use home equity to fund their retirement and more.
How Americans Are Being Penalized For Staying In Homes Longer
As Realtor points out, there was a significant oversight that Congress did not consider in 1997: inflation and rising home costs.
Home prices have increased by more than 260%, but the tax exemption has remained relatively unchanged. According to research from the University of Illinois, Chicago, if the rule kept pace, the cap would now be around $660,000 for individuals and $1.32 million for couples.
Nationwide, the average potential federal tax bill for homeowners with over-limit balances is around $35,000. However, every state is not the same. In Hawaii, which tops the list, more than 79% of homeowners could be impacted by the $250,000 exclusion limit. The average capital gain excluded in Hawaii is more than $400,000. In Washington State, more than 65% of homeowners are at risk of foreclosure. States like West Virginia and Mississippi are experiencing the least impact, with fewer than 10% of homeowners affected.
This means homeowners are sitting on equity they cannot unlock without incurring a significant cost. It’s also creating a strain in the housing market. Fewer people are likely to sell or downsize to avoid the tax, where the supply is needed the most. Instead, homeowners are staying in place until they pass away. If they hold the house, their heirs receive a stepped-up basis and avoid the capital gains bill altogether.
“Many people don’t consider their home as a capital asset that they have to pay tax on,” Liddiard adds. “And now, we’re suddenly getting to the point where a whole generation is finding out from their accountant that if they sell their house, they’re going to have to pay $80,000 or $200,000 or whatever it might be in capital gains tax. And they’re saying, ‘What? I had no idea!”
What Needs To Happen Next To Save Home Equity Advantages
By 2030, the number of people expected to have more home equity than the federal capital gains tax allows is expected to grow to 56% of homeowners. Without action, the hidden tax is expected to continue growing.
Industry advocates say the solution is for Congress to move forward with the bipartisan proposal, “The More Homes on the Market Act.” The proposal doubles the current exemption to $500,000 for individuals and $1 million for couples.
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