The Exclusion of Capital Gains for OwnerOccupied Housing

The Exclusion of Capital Gains for
February 2, 2022
Owner-Occupied Housing
Jane G. Gravelle
For 70 years, capital gains on sales of taxpayers’Owner-Occupied Housing Updated August 6, 2025 (RL32978) Jump to Main Text of Report

Contents

• Introduction
• Current Tax Treatment
• Development of the Current Rules
• Effects of the Exclusion and Cap
• Considerations Surrounding Capital Gains Tax Relief on Residences
• Labor Mobility
• Other Distortions
• Equity Issues
• Recordkeeping
• Contribution of Provision to Tax Sheltering and Avoidance
• Converting Rental Property to Owner-Occupied Property
• "Like-Kind" Property Exchanges
• Sharing Capital Gains
• Including Investment Property with the Home
• The Professional "Fixer-Upper"
• Cottage and Home
• House Swapping
• Options for Change
• Eliminating the Ceilings
• Indexing the Dollar Cap
• The Single Versus Joint Exclusion
• Changing the Structure of the Exclusion
• Tax Sheltering of Investment Gains
• Conclusion

Summary

In recent Congresses, multiple bills have been introduced to alter the exclusion of capital gains tax on sales of owner-occupied housing, and in July 2025 President Trump indicated that the Administration is considering an elimination of the capital gains tax on homes.

For 70 years, capital gains on sales of taxpayers' homes have been preferentially treated. A homes have been preferentially treated. A
Senior Specialist in
revision in 1997 replaced two revision in 1997 replaced two longstandinglong-standing provisions—a provision allowing uncapped capital provisions—a provision allowing uncapped capital
Economic Policy
gains tax deferral (i.e., a rollover) when a new residence was purchased and a provision allowing gains tax deferral (i.e., a rollover) when a new residence was purchased and a provision allowing

a one-time exclusion of $125,000 for sellers over a one-time exclusion of $125,000 for sellers over agedage 55—with a capped exclusion for each 55—with a capped exclusion for each
sale. Although the cap adopted in 1997sale. Although the cap adopted in 1997 —$500,000 for married couples and $250,000 for single taxpayers—was higher than the cap for the over-was higher than the cap for the over-agedage-55 sellers, it -55 sellers, it

was less generous than the uncapped rollover provision. In addition, the dollar cap was not was less generous than the uncapped rollover provision. In addition, the dollar cap was not
indexed for price changes, and, unlike the previous over-indexed for price changes, and, unlike the previous over-agedage-55 cap, was half as large for unmarried taxpayers-55 cap, was half as large for unmarried taxpayers—$500,000
for married couples and $250,000 for single taxpayers.
. Two factors in the years following the 1997 revisionTwo factors in the years following the 1997 revision, —(1) the rapid rise in housing prices and (2) interest in tax reform(1) the rapid rise in housing prices and (2) interest in tax reform,
—suggested the capital gains exclusion, including the dollar cap, might be reconsidered. In the suggested the capital gains exclusion, including the dollar cap, might be reconsidered. In the 109th119^th Congress, two bills have been introduced: H.R. 1340 (Panetta) to double the exemptions and index them for inflation and H.R. 4327 (Greene) to eliminate the ceiling. In the 118^th Congress, H.R. 1321 (Panetta) and H.R. 10009 (Lawler) would have doubled the exemptions and indexed them for inflation. Bills in previous Congresses also addressed this provision. In the 109^th Congress, H.R. 2127 would have allowed taxpayers over the age of 50 to double the current exclusion, once in their lifetime. H.R. 2757 would have indexed the exclusion to price changes. Given concerns about recently rising housing prices and inflation in general, some policymakers may Congress, two bills were
introduced to address this issue. H.R. 2127 would have allowed taxpayers over the age of 50 to double the current exclusion,
once in their lifetime. H.R. 2757 would have indexed the exclusion to price changes. Other legislation (H.R. 3803 and S.
4075) was introduced to change the amount of the exclusion for surviving spouses to that of a married couple. In the 110th
Congress, S. 138 was introduced to allow a surviving spouse to exclude up to $500,000 of gain from the sale or exchange of a
principal residence owned jointly with a deceased spouse if the sale or exchange occurs within two years of the death of the
spouse. That provision was enacted as part of the Mortgage Forgiveness Debt Relief Act of 2007 (P.L. 110-142) on
December 20, 2007. The Mortgage Forgiveness Debt Relief Act of 2007 had been proposed in response to the financial crisis
and downturn in the housing market. Since then, no further legislative proposals for changing the exclusion have been made.
Given concerns about recently rising housing prices and inflation in general, policymakers may wish to reconsider the reconsider the
$250,000/$500,000$250,000/$500,000 cap. The current treatment of capital gains could be maintained. However, some consideration might be cap. The current treatment of capital gains could be maintained. However, some consideration might be
given to changing the dollar ceiling. One option is to eliminate the ceiling. given to changing the dollar ceiling. One option is to eliminate the ceiling. A notherAnother option is to adjust the ceiling for price option is to adjust the ceiling for price
changes.changes.
Some have criticized the significant tax benefits for owner-occupied housing. Capital gains treatment is one of those benefits. Some have criticized the significant tax benefits for owner-occupied housing. Capital gains treatment is one of those benefits.
Yet, there isOthers may see an efficiency argument for eliminating or excluding a large portion of the tax gain on homes. Capital gains taxes an efficiency argument for eliminating or excluding a large portion of the tax gain on homes. Capital gains taxes
on homes create barriers to labor mobility in the economy. Imposing capital gains taxes on homes also creates significant on homes create barriers to labor mobility in the economy. Imposing capital gains taxes on homes also creates significant
compliance costs, requiring individuals to keep records for decades and to make fine distinctions between improvements and compliance costs, requiring individuals to keep records for decades and to make fine distinctions between improvements and
repairs. Capital gains taxes also tend to distort housing choices, discouraging individuals from selling their homes because of repairs. Capital gains taxes also tend to distort housing choices, discouraging individuals from selling their homes because of
changing family and health circumstances. changing family and health circumstances. MoreoverAlso, while the exclusion favors homeowners relative to renters, the taxation , while the exclusion favors homeowners relative to renters, the taxation
of gains in excess of a cap creates inequities between homeowners with different job circumstances, between those living in of gains in excess of a cap creates inequities between homeowners with different job circumstances, between those living in
different parts of the country, and between those with different health outcomes. Exclusions of gains on homes different parts of the country, and between those with different health outcomes. Exclusions of gains on homes do, however,
can also contribute to tax avoidance schemes, especially ones that allow gains on investment properties to escape tax.

Introduction

In recent Congresses, multiple bills have been introduced to alter the exclusion of capital gains on sales of owner-occupied housing, and in July 2025 President Trump indicated that the Administration is considering an elimination of the capital gains tax on homes. In the 119^th Congress, two bills have been introduced: H.R. 1340 (Panetta) to double the exemptions and index them for inflation and H.R. 4327 (Greene) to eliminate the ceiling.

For 70 years, capital gains on sales of taxpayers'contribute to tax avoidance schemes, especially ones that allow gains on investment properties to escape tax.

Congressional Research Service

---

link to page 4 link to page 4 link to page 5 link to page 8 link to page 9 link to page 10 link to page 11 link to page 11 link to page 12 link to page 13 link to page 13 link to page 14 link to page 14 link to page 15 link to page 15 link to page 15 link to page 15 link to page 15 link to page 16 link to page 18 link to page 18 link to page 19 link to page 20 link to page 20 link to page 22 The Exclusion of Capital Gains for Owner-Occupied Housing

Contents
Introduction ................................................................................................................... 1
Current Tax Treatment ..................................................................................................... 1
Development of the Current Rules ..................................................................................... 2
Effects of the Exclusion and Cap ....................................................................................... 5
Is Relief From the Capital Gains Tax on Residences Justified? ............................................... 6
Labor Mobility .......................................................................................................... 7
Other Distortions ....................................................................................................... 8
Equity Issues ............................................................................................................ 8
Recordkeeping .......................................................................................................... 9
Contribution of Provision to Tax Sheltering and Avoidance ............................................ 10
Converting Rental Property to Owner-Occupied Property ......................................... 10
“Like-Kind” Property Exchanges .......................................................................... 11
Sharing Capital Gains ......................................................................................... 11
Including Investment Property with the Home ........................................................ 12
The Professional “Fixer-Upper”............................................................................ 12
Cottage and Home .............................................................................................. 12
House Swapping ................................................................................................ 12
Options for Change ....................................................................................................... 12
Eliminating the Ceilings ........................................................................................... 13
Indexing the Dollar Cap............................................................................................ 15
The Single Versus Joint Exclusion .............................................................................. 15
Changing the Structure of the Exclusion...................................................................... 16
Tax Sheltering of Investment Gains ............................................................................ 17
Conclusion................................................................................................................... 17

Contacts
Author Information ....................................................................................................... 19

Congressional Research Service

---

The Exclusion of Capital Gains for Owner-Occupied Housing

Introduction
For 70 years, capital gains on sales of taxpayers’ homes have been given preferential treatment. A homes have been given preferential treatment. A
revision in 1997 replaced two revision in 1997 replaced two longstandinglong-standing provisions—a provision provisions—a provision al owingallowing an uncapped capital an uncapped capital
gains tax deferral (i.e., a rollover) when a new residence is purchased and a one-time exclusion of gains tax deferral (i.e., a rollover) when a new residence is purchased and a one-time exclusion of
$125,000 of capital gains for $125,000 of capital gains for sel erssellers over over agedage 55—with a capped exclusion for each sale. 55—with a capped exclusion for each sale.
Although the 1997 capAlthough the 1997 cap —$500,000 for married couples and $250,000 for single taxpayers—was higher than the previous cap for the over-was higher than the previous cap for the over-aged-55 sel ersage-55 sellers, it was less , it was less
generous than the uncapped rollover provision it replaced. In addition, the dollar cap was not generous than the uncapped rollover provision it replaced. In addition, the dollar cap was not
indexed for price changes, and, unlike the previous over-indexed for price changes, and, unlike the previous over-agedage-55 cap, was half as large for -55 cap, was half as large for
unmarried taxpayersunmarried taxpayers—$500,000 for married couples and $250,000 for single taxpayers. The
. The exclusion is exclusion is al owedallowed once every two years, subject to taxpayers meeting ownership and use tests. once every two years, subject to taxpayers meeting ownership and use tests.
The cap was presumably meant to eliminate any capital gains tax on home sales for the vast The cap was presumably meant to eliminate any capital gains tax on home sales for the vast
majority of taxpayers, but the rise in housing prices and the passage of time have reduced the majority of taxpayers, but the rise in housing prices and the passage of time have reduced the
value of the exclusion. With no revision and an increase in housing prices, an increasing share of value of the exclusion. With no revision and an increase in housing prices, an increasing share of
gains would be subject to tax.gains would be subject to tax.
Housing prices Housing prices fel fell during the financial crisis and did not regain their 2007 high point until 2013, during the financial crisis and did not regain their 2007 high point until 2013,
when they again began rising. They rose steeply during the COVID-19 recession and recovery. If when they again began rising. They rose steeply during the COVID-19 recession and recovery. If
the $250,000 and $500,000 values had been increased to reflect the change in the average housing the $250,000 and $500,000 values had been increased to reflect the change in the average housing
price between 1998 and price between 1998 and 20212025, they would now be approximately $, they would now be approximately $650720,000 and $1,,000 and $1,300440,000, ,000,
respectively; if they had been increased to reflect the median housing price by respectively; if they had been increased to reflect the median housing price by 20212025, they would , they would
be $be $700715,000 and $1,,000 and $1,400430,000, respectively.,000, respectively.11 If they had been increased to reflect the general price If they had been increased to reflect the general price
rise in the economy (the gross domestic product, or GDP, deflator), they would be $rise in the economy (the gross domestic product, or GDP, deflator), they would be $400457,000 and ,000 and
$800$913,000, respectively.,000, respectively.22
This report examines the capital gains exclusion and the cap. The first section describes the This report examines the capital gains exclusion and the cap. The first section describes the
current tax rules, the second section presents the historical development of the capital gains current tax rules, the second section presents the historical development of the capital gains
provisions, and the third, the coverage and cost. It then discusses potential justifications for provisions, and the third, the coverage and cost. It then discusses potential justifications for
capital gains relief, as capital gains relief, as wel well as tax avoidance problems that may arise. The final section discusses as tax avoidance problems that may arise. The final section discusses
various options for change, primarily focusing on the dollar ceiling.various options for change, primarily focusing on the dollar ceiling.
Current Tax Treatment
When an individualWhen an individual sel s sells a personal residence, the excess of the sales price over the original cost a personal residence, the excess of the sales price over the original cost
plus improvements is a capital gain and is subject to tax. The individual is able to deduct any plus improvements is a capital gain and is subject to tax. The individual is able to deduct any
costs of the sale (such as commissions and advertising), and may be required to include gain that costs of the sale (such as commissions and advertising), and may be required to include gain that
was deferred from previous home sales.was deferred from previous home sales.
Gain up to $250,000 for single taxpayers and $500,000 for married couples filing joint returns is Gain up to $250,000 for single taxpayers and $500,000 for married couples filing joint returns is
excluded if the taxpayer meets a use test (has lived in the house for at least two years out of the excluded if the taxpayer meets a use test (has lived in the house for at least two years out of the
last five years) and an ownership test (has owned the house, also for two years out of the last last five years) and an ownership test (has owned the house, also for two years out of the last
five). The exclusion can be used every two years.3

1 For average and median house prices, see FRED Economic Data, Average Prices of Houses Sold for the United
States, https://fred.stlouisfed.org/series/ASPUS and Median Sales Price of Houses Sold for the United States,
https://fred.stlouisfed.org/series/MSPUS.
2 See Bureau of Economic Analysis, National Income and Product Accounts, T able 1.1.4, https://apps.bea.gov/iTable/
iT able.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey.
3 Some exceptions to these rules exist. If taxpayers have not lived in the primary residence for a total of two years out
Congressional Research Service

1

---

The Exclusion of Capital Gains for Owner-Occupied Housing

five). The exclusion can be used every two years.³ To minimize the tax, assuming the individualTo minimize the tax, assuming the individual is subject to it, he or she must keep records of any is subject to it, he or she must keep records of any
improvements during the entire time the home is owned and also, to comply with the law, improvements during the entire time the home is owned and also, to comply with the law,
appropriately distinguish between expenditures that are repairs, which do not reduce gain, and appropriately distinguish between expenditures that are repairs, which do not reduce gain, and
those that are improvements, which do reduce gain.those that are improvements, which do reduce gain.
For homes that were acquired before the 1997 change in tax law, there may also be deferred gain For homes that were acquired before the 1997 change in tax law, there may also be deferred gain
from previously owned residences. Under pre-1997 tax law, a taxpayer could defer the gain on a from previously owned residences. Under pre-1997 tax law, a taxpayer could defer the gain on a
home sale if another residence was purchased. If the new residence cost as much or more than the home sale if another residence was purchased. If the new residence cost as much or more than the
old residence sold for, the tax on the entire gain was deferred. If the new residence cost less than old residence sold for, the tax on the entire gain was deferred. If the new residence cost less than
the sale price of the old residence, gains tax was due on the difference between the value of the the sale price of the old residence, gains tax was due on the difference between the value of the
old and new residence (if less than the gain) and tax on the remainder was deferred. The old and new residence (if less than the gain) and tax on the remainder was deferred. The
additional gain from previously owned residences makes it more likely that total gains additional gain from previously owned residences makes it more likely that total gains wil
will exceed the cap; had the 1997 law been in place for many years, much or exceed the cap; had the 1997 law been in place for many years, much or al all of the prior gain of the prior gain
would have been excluded.would have been excluded.
Capital gains on homes (and assets Capital gains on homes (and assets general ygenerally) held at least a year are taxed at lower rates that are ) held at least a year are taxed at lower rates that are
linked to the permanent rate schedule linked to the permanent rate schedule (and not the temporary one effective for 2018-2025prior to the 2017 tax cuts (P.L. 115-97): 0% ): 0%
for taxpayers in the 10% and 15% marginal income tax brackets; 15% for taxpayers in marginal for taxpayers in the 10% and 15% marginal income tax brackets; 15% for taxpayers in marginal
income tax brackets above 15%, but below the top rate; and 20% for higher-income taxpayers. income tax brackets above 15%, but below the top rate; and 20% for higher-income taxpayers.
For For 20222025, the 15% rate begins applying at an adjusted gross income level of $, the 15% rate begins applying at an adjusted gross income level of $83,35096,700 for joint for joint
returns ($returns ($41,67548,350 for single returns) and the 20% rate begins applying at $ for single returns) and the 20% rate begins applying at $517,200600,050 for joint returns for joint returns
($450,750($533,400 for single returns). An additional 3.8% net investment income tax applies to taxpayers for single returns). An additional 3.8% net investment income tax applies to taxpayers
with incomes over $250,000 for married couples and $200,000 for singles. Neither the capital with incomes over $250,000 for married couples and $200,000 for singles. Neither the capital
gains tax nor the net investment income tax applies to excluded gains.gains tax nor the net investment income tax applies to excluded gains.
A special relief provision for military families and the Foreign Service A special relief provision for military families and the Foreign Service al owsallows them to expand the them to expand the
five-year period for the ownership and use tests to up to 10 years while on qualified official duty.five-year period for the ownership and use tests to up to 10 years while on qualified official duty.
Another provision that may influence a taxpayerAnother provision that may influence a taxpayer’'s decision about s decision about sel ingselling a residence is a long- a residence is a long-
standing provision that standing provision that al owsallows the gain to be excluded entirely if the taxpayer does not the gain to be excluded entirely if the taxpayer does not sel sell the the
home and leaves it as part of his or her estate. If an individual keeps his or her house until death home and leaves it as part of his or her estate. If an individual keeps his or her house until death
and leaves it to heirs, no tax on gain accumulated would be due, because the heir would be able to and leaves it to heirs, no tax on gain accumulated would be due, because the heir would be able to
deduct the fair market value at time of death from sales price. Tax may be due if the heirs do not deduct the fair market value at time of death from sales price. Tax may be due if the heirs do not
sel sell the home immediately after inheriting the property if the property increases in value. This the home immediately after inheriting the property if the property increases in value. This
rule is rule is cal edcalled a step-up in basis. a step-up in basis.
Development of the Current Rules
The gain realized upon the sale of a personal residence was taxed as capital gain until the passage The gain realized upon the sale of a personal residence was taxed as capital gain until the passage
of the Revenue Act of 1951 (P.L. 82-183). At that time, Congress passed a rollover provision that of the Revenue Act of 1951 (P.L. 82-183). At that time, Congress passed a rollover provision that
al owedallowed for the deferral of capital gains tax if the proceeds of the sale were used to buy another for the deferral of capital gains tax if the proceeds of the sale were used to buy another

of the last five, they are eligible for a partial exclusion cap if the real estate was sold because of a change in
employment, health, or unforeseen circumstances. T he taxpayer can receive a portion of the exclusion cap, based on the
portion of the two-year period they resided in the home. For example, a single taxpayer who lived in the house for one
year and qualified for an exception would have a $125,000 cap. For people living in a nursing home, the ownership and
use test is lowered to one out of five years before entering the facility. And time spent in the nursing home still counts
toward ownership time and use of the residence. For example, if a taxpayer lived in a house for a year, and then spent
the next five years in a nursing home before selling the home, the full $250,000 exclusion would be available.
No rationale is stated in the legislative history of this long-standing provision, although proposals have been made to
alter it. One justification is to address the difficulty with establishing basis for assets held for a long time.
Congressional Research Service

2

---

The Exclusion of Capital Gains for Owner-Occupied Housing

residence of equal or greater value within a year before or after the sale of the old residence.
residence of equal or greater value within a year before or after the sale of the old residence. Congress stated that the rollover provision was in response to transactions that wereCongress stated that the rollover provision was in response to transactions that were
necessitated by such facts as an increase in the size of the family or a change in the place necessitated by such facts as an increase in the size of the family or a change in the place
of the taxpayerof the taxpayer’'s employment. In these situations the transaction partakes of the nature of s employment. In these situations the transaction partakes of the nature of
an involuntary conversion. Cases of this type are particularly numerous in periods of rapid an involuntary conversion. Cases of this type are particularly numerous in periods of rapid
change such as mobilization or reconversion.change such as mobilization or reconversion.⁴ 4
At that time, the economy had grown as a result of industrialization and residential moves were At that time, the economy had grown as a result of industrialization and residential moves were
more frequent due to business transfers and other employment related changes. Congress also more frequent due to business transfers and other employment related changes. Congress also
recognized that capital gains from home sales were, in part, a result of general inflation. During recognized that capital gains from home sales were, in part, a result of general inflation. During
the congressional debate, the rollover provision was justified on the grounds that homeowners the congressional debate, the rollover provision was justified on the grounds that homeowners
were changing homes, not to make a profit as investors, but rather in response to employment or were changing homes, not to make a profit as investors, but rather in response to employment or
family size changes.family size changes.
The first exclusion from taxation for capital gains on the sale of a primary residence was enacted The first exclusion from taxation for capital gains on the sale of a primary residence was enacted
by the Revenue Act of 1964 (P.L. 88-272). The provision was available only for the elderly (aged by the Revenue Act of 1964 (P.L. 88-272). The provision was available only for the elderly (aged
65 and older) and applied to residences sold after 1963. It was available on a one-time basis only, 65 and older) and applied to residences sold after 1963. It was available on a one-time basis only,
and was at the same level for both single and married individuals. To qualify, the house had to be and was at the same level for both single and married individuals. To qualify, the house had to be
occupied for five of the previous eight years. The exclusion of gain was limited to the amount occupied for five of the previous eight years. The exclusion of gain was limited to the amount
attributable to the first $20,000 of sales price. Above that level, a ratio was used to determine the attributable to the first $20,000 of sales price. Above that level, a ratio was used to determine the
gain subject to taxation, such that the amount of the exclusion depended on the relationship of gain subject to taxation, such that the amount of the exclusion depended on the relationship of
sales price to basis, as sales price to basis, as wel well as the relationship between $20,000 and sales price. For example, if as the relationship between $20,000 and sales price. For example, if
the sales price were $40,000, one-half of the gain ($20,000/$40,000) could be excluded. the sales price were $40,000, one-half of the gain ($20,000/$40,000) could be excluded.
However, the actual amount excluded would be less than $20,000, unless the house However, the actual amount excluded would be less than $20,000, unless the house original y
originally cost $20,000. For example, if the basis in the house was $10,000, the gain on the $40,000 sale cost $20,000. For example, if the basis in the house was $10,000, the gain on the $40,000 sale
would be $30,000. Of that $30,000, one half, or $15,000, would be excluded because $20,000 would be $30,000. Of that $30,000, one half, or $15,000, would be excluded because $20,000
was half the sales price.was half the sales price.
The reason given for the exclusion was to reduce the burden on elderly taxpayers who would The reason given for the exclusion was to reduce the burden on elderly taxpayers who would
have to tie up have to tie up al all of their investment in a new home to avoid paying capital gains tax. The dollar of their investment in a new home to avoid paying capital gains tax. The dollar
restriction was due to a focus on the average and restriction was due to a focus on the average and smal ersmaller home, thus suggesting a distributional home, thus suggesting a distributional
motive.5
motive.⁵ The amount of capital gains excludable from taxation for older taxpayers was increased three The amount of capital gains excludable from taxation for older taxpayers was increased three
times in response to higher housing prices. The three increases were enacted by The Tax Reform times in response to higher housing prices. The three increases were enacted by The Tax Reform
Act of 1976 (P.L. 94-455), the Revenue Act of 1978 (P.L. 95-600), the Economic Recovery Tax Act of 1976 (P.L. 94-455), the Revenue Act of 1978 (P.L. 95-600), the Economic Recovery Tax
Act of 1981 (P.L. 97-34) and Act of 1981 (P.L. 97-34) and final yfinally, the Taxpayer Relief Act of 1997 (P.L. 105-34). The limit for , the Taxpayer Relief Act of 1997 (P.L. 105-34). The limit for
elderly homeowners rose to $35,000 in 1976, $100,000 in 1978, and $125,000 in 1981. The 1978 elderly homeowners rose to $35,000 in 1976, $100,000 in 1978, and $125,000 in 1981. The 1978
provision also liberalizedprovision also liberalized the benefit by simply the benefit by simply al owingallowing an exclusion rather than a proportional an exclusion rather than a proportional
share that depended on basis and lowered the age limit to 55. (There was consideration of share that depended on basis and lowered the age limit to 55. (There was consideration of
eliminating eliminating the age requirement altogether.) The 1978 change also reduced the holding period the age requirement altogether.) The 1978 change also reduced the holding period
requirement to three out of the previous eight years.requirement to three out of the previous eight years.
In each case of capital gains relief, Congress cited the rising sale prices of homes as the source of In each case of capital gains relief, Congress cited the rising sale prices of homes as the source of
large amounts of taxable capital gains on residences and the reason for adjusting the amount of large amounts of taxable capital gains on residences and the reason for adjusting the amount of
capital gains that could be excluded from taxation.

4 U.S. Congress, Senate Committee on Finance, The Revenue Act of 1951: Report to Accompany H.R. 4473, 82nd
Cong., 1st sess., S.Prt. 82-781 (Washington: GPO, 1951), p. 34.
5 U.S. Congress, House Ways and Means Committee, Report to Accompany H.R. 8363, 88th Cong., 1st sess., H. Prt. 88-
749 (Washington: GPO, 1963).
Congressional Research Service

3

---

The Exclusion of Capital Gains for Owner-Occupied Housing

capital gains that could be excluded from taxation. When the rollover provisions and one-time exclusion for the elderly were replaced by the current When the rollover provisions and one-time exclusion for the elderly were replaced by the current
exclusion (in the Taxpayer Relief Act of 1997, P.L. 105-34), a major reason given was to reduce exclusion (in the Taxpayer Relief Act of 1997, P.L. 105-34), a major reason given was to reduce
the recordkeeping burden and to eliminate the need for referring to records and making the recordkeeping burden and to eliminate the need for referring to records and making
judgements about what expenditures are improvements.judgements about what expenditures are improvements.
Other reasons cited for changing the tax law were to limit the distortions in behavior arising from Other reasons cited for changing the tax law were to limit the distortions in behavior arising from
the rollover treatment and from those elderly who had exceeded the exclusion limit or had already the rollover treatment and from those elderly who had exceeded the exclusion limit or had already
used it. Because the full deferral of tax required the purchase of a new residence of equal or used it. Because the full deferral of tax required the purchase of a new residence of equal or
greater value, the law may have encouraged taxpayers to purchase more expensive homes than greater value, the law may have encouraged taxpayers to purchase more expensive homes than
they otherwise would have. The pre-1997 rules also discouraged some elderly taxpayers from they otherwise would have. The pre-1997 rules also discouraged some elderly taxpayers from
sel ingselling their homes to avoid possible tax consequences. As a result, elderly taxpayers who had their homes to avoid possible tax consequences. As a result, elderly taxpayers who had
already used their one-time exclusion and those who might have realized a gain in excess of already used their one-time exclusion and those who might have realized a gain in excess of
$125,000 may have retained their homes even though it was desirable for them to move.$125,000 may have retained their homes even though it was desirable for them to move.
It was also clear from statistical data that between rollovers, exclusions, step-up in basis (which It was also clear from statistical data that between rollovers, exclusions, step-up in basis (which
al owedallowed capital gains to be avoided if the home were held until death and left to heirs), and under- capital gains to be avoided if the home were held until death and left to heirs), and under-
reporting, very little capital gains on owner-occupied housing were taxed. Thus, little revenue reporting, very little capital gains on owner-occupied housing were taxed. Thus, little revenue
was gained from a set of provisions that, nevertheless, caused distortions in behavior and was gained from a set of provisions that, nevertheless, caused distortions in behavior and
complicated compliance. These observations supported a simple elimination of the capital gains complicated compliance. These observations supported a simple elimination of the capital gains
tax on principal residences.tax on principal residences.
In 1997, Congress imposed what was characterized as a In 1997, Congress imposed what was characterized as a “"relatively highrelatively high”" ceiling on the amount of ceiling on the amount of
excluded gain, $500,000 for married couples. In a departure from the historic treatment of excluded gain, $500,000 for married couples. In a departure from the historic treatment of
lifetime exclusions, however, the exclusion was only half as large for single taxpayers as for lifetime exclusions, however, the exclusion was only half as large for single taxpayers as for
married couples—$250,000. The previous treatment had cut the exclusion in half for married married couples—$250,000. The previous treatment had cut the exclusion in half for married
couples filing separately but not for single taxpayers, an important difference given that most couples filing separately but not for single taxpayers, an important difference given that most
married individualsmarried individuals who do not divorce are who do not divorce are eventual yeventually widowed. Unlike the lifetime exclusion, widowed. Unlike the lifetime exclusion,
however, the exclusion could be taken in each period. In contrast to many other dollar limits in however, the exclusion could be taken in each period. In contrast to many other dollar limits in
the tax code, the amount of the exclusion was not indexed, so that it, like the previous exclusion, the tax code, the amount of the exclusion was not indexed, so that it, like the previous exclusion,
might need to be might need to be periodical y periodically revisited.revisited.
Two bil s Two bills in the in the 109th109^th Congress addressed this provision. H.R. 2127, introduced by Representative Congress addressed this provision. H.R. 2127, introduced by Representative
Filner, would have Filner, would have al owedallowed taxpayers over the age of 50 to exclude an amount that is double the taxpayers over the age of 50 to exclude an amount that is double the
current cap, but it was available only once in their lifetime.current cap, but it was available only once in their lifetime. H.R. 2757, introduced by H.R. 2757, introduced by
Representative Andrews, would have indexed the exclusion. Other legislation (H.R. 3803 by Representative Andrews, would have indexed the exclusion. Other legislation (H.R. 3803 by
Representative McCarthy and S. 4075 by Senator Schumer) was introduced to change the amount Representative McCarthy and S. 4075 by Senator Schumer) was introduced to change the amount
of the exclusion for surviving spouses to that of a married couple.of the exclusion for surviving spouses to that of a married couple.
In the In the 110th110^th Congress, S. 138 was introduced to Congress, S. 138 was introduced to al owallow a surviving spouse to exclude up to a surviving spouse to exclude up to
$500,000 of gain from the sale or exchange of a principal residence owned jointly with a $500,000 of gain from the sale or exchange of a principal residence owned jointly with a
deceased spouse if the sale or exchange occurs within two years of the death of the spouse. That deceased spouse if the sale or exchange occurs within two years of the death of the spouse. That
provision was also included in H.R. 3648, the Mortgage Forgiveness Debt Relief Act of 2007, provision was also included in H.R. 3648, the Mortgage Forgiveness Debt Relief Act of 2007,
which was signed into law as P.L. 110-142 on December 20, 2007. Capital gains tax rates were which was signed into law as P.L. 110-142 on December 20, 2007. Capital gains tax rates were
also changed in 1997. Before that time, capital gains were taxed at ordinary rates with a 28% cap, also changed in 1997. Before that time, capital gains were taxed at ordinary rates with a 28% cap,
leading to two rates of 15% (for the ordinary 15% bracket) and 28% for leading to two rates of 15% (for the ordinary 15% bracket) and 28% for al all other brackets. The other brackets. The
1997 legislation1997 legislation reduced those rates to 10% and 20%, respectively. In 2003, rates were reduced to reduced those rates to 10% and 20%, respectively. In 2003, rates were reduced to
15% for 2003-2008 for those in the higher brackets and to 5% in 2003-2007 and 0% in 2008 for 15% for 2003-2008 for those in the higher brackets and to 5% in 2003-2007 and 0% in 2008 for
taxpayers in the 15% bracket or lower. These rates were extended and in 2012 made permanent, taxpayers in the 15% bracket or lower. These rates were extended and in 2012 made permanent,
with a rate of 20% for the top bracket, leading to the current rates of 0%, 15%, and 20%. Health with a rate of 20% for the top bracket, leading to the current rates of 0%, 15%, and 20%. Health
reform legislation in 2010 provided for a tax of 3.8% on high-income taxpayers on various forms reform legislation in 2010 provided for a tax of 3.8% on high-income taxpayers on various forms
of passive income, including capital gains. The exclusion also applies to the 3.8% tax.of passive income, including capital gains. The exclusion also applies to the 3.8% tax.
Congressional Research Service

4

---

The Exclusion of Capital Gains for Owner-Occupied Housing

Effects of the Exclusion and Cap
The revenue cost of the exclusion is estimated at $40.3 bil ion for FY2022.6 The initial In the 119th Congress, two bills have been introduced: H.R. 1340 (Panetta) to double the exemptions and index them for inflation and H.R. 4327 (Greene) to eliminate the ceiling. In the 118^th Congress, two bills were introduced: H.R. 1321 (Panetta) and H.R. 10009 (Lawler), both of which would have doubled the exemptions and indexed them for inflation. Effects of the Exclusion and Cap The revenue cost of the exclusion is estimated at $46.4 billion for FY2025.⁶ The initial estimate estimate
for this provision was $5.6 for this provision was $5.6 bil ionbillion in FY1998, although the estimate was more than doubled to in FY1998, although the estimate was more than doubled to
$12.9 $12.9 bil ion billion for FY2000 (which may have reflected better data availability).for FY2000 (which may have reflected better data availability).77 These estimates These estimates
were were smal ersmaller than the amounts estimated for the previous provisions that than the amounts estimated for the previous provisions that al owedallowed unlimited unlimited
deferral of taxes with a replacement home ($8.6 deferral of taxes with a replacement home ($8.6 bil ionbillion for FY1997) and the more limited for FY1997) and the more limited
exclusion of gains for those over the age of 55 ($4.9 exclusion of gains for those over the age of 55 ($4.9 bil ion billion for FY1997).for FY1997).
A study examining the provision using 2007 data indicated that 0.57% of home transactions were A study examining the provision using 2007 data indicated that 0.57% of home transactions were
subject to the $500,000 and $250,000 ceilings. An additionalsubject to the $500,000 and $250,000 ceilings. An additional 1.17% had taxable gain due to sales 1.17% had taxable gain due to sales
that did not meet the holding period requirements. Thus, that did not meet the holding period requirements. Thus, almost al few taxpayers owed taxpayers owed no capital capital
gains tax on the sale of gains tax on the sale of principleprincipal residences. residences.88 The share paying tax due to the ceilings represented The share paying tax due to the ceilings represented
a rise from the time of enactment, when a much a rise from the time of enactment, when a much smal ersmaller number of transactions was expected to number of transactions was expected to
be subject to the exclusion. Data from 1999 indicated that only 0.04% of taxpayers were be subject to the exclusion. Data from 1999 indicated that only 0.04% of taxpayers were
affected.affected.99 The rise in the share reflected the 58% increase in the average and median price of The rise in the share reflected the 58% increase in the average and median price of
houses between 1999 and 2007.houses between 1999 and 2007.
Data are not availableData are not available to project the number of transactions affected currently, but the share to project the number of transactions affected currently, but the share
should rise significantly, as average house prices have risen by should rise significantly, as average house prices have risen by 6775% for the median sale and % for the median sale and 50%
65% for the average since 2007. Current data on sales prices of existing homes indicate that for the average since 2007. Current data on sales prices of existing homes indicate that 2935% of % of
home sale prices in home sale prices in 20212025 were at $500,000 or more and were at $500,000 or more and 4345% were at prices of $250,000 to % were at prices of $250,000 to
$500,000.$500,000.1010 Because about a third of sales involved single individuals, assuming they were evenly Because about a third of sales involved single individuals, assuming they were evenly
distributed in the $250,000 to $500,000 class, distributed in the $250,000 to $500,000 class, 4350% of taxpayers had sale prices that could % of taxpayers had sale prices that could
potential ypotentially expose them to capital gains taxes (as compared to 3% at the time the provision was expose them to capital gains taxes (as compared to 3% at the time the provision was
enacted). The fraction subject to the tax would depend on basisenacted). While sales price is one variable that determines the fraction of home sellers actually subject to the tax, another factor depends on the difference between the basis (the cost of acquiring the home plus any improvements) and the sales price. In the 2007 data, basis was . In the 2007 data, basis was
around 50% of sales price. Although there is no way to estimate the share subject to tax, around 50% of sales price. Although there is no way to estimate the share subject to tax, the data
for 2021 indicate that 13% of sales prices were above $750,000 and 7% were above $1 mil ion.
Significant portions of these taxpayers were likely to pay taxes because of the limit, as wel as
some portion in the 30% above the $250,000 range but below the $750,000 levelgiven this basis a small portion (e.g., single filers selling near the top of the price range) of sales between $250,000 and $500,000 would owe taxes. Taxpayers in this category. Taxpayers in
these categories most likely to be subject to tax are those who have owned their homes for a long most likely to be subject to tax are those who have owned their homes for a long
time and have a low basis. time and have a low basis.
The share ofThe data for 2021 also indicate that 16% of sales prices were above $750,000 and 8% were above $1 million. Significant portions of these taxpayers were likely to pay taxes because of the limit. The gains subject to tax because of the limit gains subject to tax because of the limit ishave been estimated at 9% of the excluded tax for estimated at 9% of the excluded tax for
2007.2007.¹¹ The The gaingains due to nonqualifying sales due to nonqualifying sales ishave been estimated at 1.3% of the excluded tax. These shares would be higher because of the increase in the top rate of the capital gains tax from 15% to 20%, implying around a 12% share compared to a 9% share for the effect of the limit if all included gain is subject to a 20% tax and all excluded gain is subject to a 15% rate (9% times 20/15 equals 12%).¹² Most of the included gain would probably be subject to the additional net investment income tax of 3.8%, which would raise the share to around 14% (9% times 23.8/15 equals 14.3%). If this ratio applied to the current $46.3 billion estimate, the tax on included gain would be $6.5 billion.

The tax would be larger, however, because the increase in prices increases gains while holding the ceiling fixed, and gains would increase proportionally more. For example, a house with a sales price of $2 million, with a basis of 50% or $1 million, would leave a gain of $1 million, with $0.5 million above the cap. Now prices increase by 65% so that the price is $3.3 million and gain is $1.65 million, with $1.15 million above the cap. The $0.5 million gain from 2007 is adjusted to $0.825 using current tax expenditure estimates, but the actual gain is now $1.15 million; a further increase of 39% is needed to bring the $0.825 million up to $1.15 million. How large this adjustment is depends on the distribution of gains within the affected group. Using only growth rates and assuming the same type of distribution in 2007, the average sales price necessary to produce a 9% share of gain taxed would be $1.34 million and would suggest an additional doubling of the revenue loss. However, because of the shape of the distribution (proportionally more taxable gain associated with higher-priced houses in the category), it would be smaller than $10 billion.

Considerations Surrounding Capital Gains Tax Relief on Residences estimated at 1.3% of the excluded tax. The current
share of the gain subject to tax because of the limits would be larger currently as wel given the

6 Joint Committee on T axation, Estimates Of Federal Tax Expenditures For Fiscal Years 2020 -2024, JCS-23-20,
November 5, 2020, https://www.jct.gov/publications/2020/jcx-23-20/.
7 Joint Committee on T axation, Estimates Of Federal Tax Expenditures For Fiscal Years 1998 -2002, JCS-22-97,
December 15, 1997, https://www.jct.gov/publications/1997/jcs-22-97/ and Estim ates Of Federal Tax Expenditures For
Fiscal Years 2000-2004, JCS-13-99, December 22, 1999, https://www.jct.gov/publications/1999/jcs-13-99/.
8 See Gerald Auten and Jane G. Gravelle, “T he Exclusion of Capital Gains on the Sale of Principal Residences: Policy
Options,” National T ax Association Proceedings, 102 Annual Conference on T axation, 2009, https://ntanet.org/wp-
content/uploads/proceedings/2009/012-auten-the-exclusion-capital-2009-nta-proceedings.pdf. Because of the way
taxpayers reported their transactions, it was not possible to determine precisely which taxpayers reached the maximum
exclusion.
9 T he Auten and Gravelle study indicated that 2,000 taxpayers were subject to the limit in 1999. In that year, home
sales were 5.21 million. See T itleNews Online Archive, “ 2001 A New Record, December Existin g-Home Sales
Strong?” NAR Reports, January 28, 2002, https://www.alta.org/news/news.cfm?20020128-2001-A-New-Record-
December-Existing-Home-Sales-Strong—NAR-Reports.
10 National Association of Realtors, “Summary of November 2021 Existing Home Sales Statistics,” December 12,
2021, https://cdn.nar.realtor/sites/default/files/documents/ehs-11-2021-summary-2021-12-22.pdf.
Congressional Research Service

5

---

The Exclusion of Capital Gains for Owner-Occupied Housing

increase in housing prices and the top capital gains tax rates. These ratios would be a little higher,
estimated currently at 11.7% and 1.8% due to the higher taxes in effect. These amounts would be
higher with the growth in home prices, as gains increase but exemptions remain constant. If these
same ratios held today, the revenue gain from the ceiling would be $3.6 bil ion, but adjusted for
the higher top tax rate it would be $4.7 bil ion. The tax savings would be even larger, however,
because the increase in prices increases gains while holding the ceiling fixed, and gains would
increase proportional y more. If the estimate is further adjusted for the 50% increase in average
home prices, just for the $500,000 and above categories, the amount would increase by a third, to
$6.3 bil ion. Further increases would also occur with other categories such as the $250,000 to
$500,000 class (where adjustments cannot easily be made and some taxpayers would not have
appeared in the 2007 data) and the $100,000 to $250,000 class that would not have appeared in
the 2007 data due to the limit in 2007.
Is Relief From the Capital Gains Tax on Residences
Justified?
Economists have often been critical of preferential treatment of certain types of activities, because Economists have often been critical of preferential treatment of certain types of activities, because
that preferential treatment distorts behavior and causes a that preferential treatment distorts behavior and causes a misal ocationmisallocation of capital. Tax preferences of capital. Tax preferences
also narrow the tax base and require higher marginal tax rates for a given revenue target; these also narrow the tax base and require higher marginal tax rates for a given revenue target; these
higher tax rates in turn magnify other distortions. Tax preferences also can be inequitable, higher tax rates in turn magnify other distortions. Tax preferences also can be inequitable,
favoring those who engage in tax-preferred activities. (Tax preferences are also sometimes favoring those who engage in tax-preferred activities. (Tax preferences are also sometimes
criticized because they favor higher-income individuals; the appropriateness of such criticisms criticized because they favor higher-income individuals; the appropriateness of such criticisms
depends on onedepends on one’'s view of how taxes should be distributed and whether such preferences are offset s view of how taxes should be distributed and whether such preferences are offset
by a more graduated rate structure.)by a more graduated rate structure.)
It is also true Some could also argue that the favorable treatment for owner-occupied housing may divert investment that the favorable treatment for owner-occupied housing may divert investment
from business investment. Absent a market failure, this from business investment. Absent a market failure, this misal ocation reducestype of perceived misallocation could be viewed as reducing the efficiency of the the efficiency of the
economy. Favorable capital gains treatment for housing is not the only tax benefit it receives, economy. Favorable capital gains treatment for housing is not the only tax benefit it receives, or
even the most importantand other benefits may have broader implications in economic terms. The implicit income from housing is not subject to in economic terms. The implicit income from housing is not subject to
tax, yet costs such as mortgage interest and property taxes are tax, yet costs such as mortgage interest and property taxes are al owedallowed as deductions, at least for as deductions, at least for
those who itemize. The benefits of itemized deductions for mortgage interest and property taxes
are currently limited under temporary changes made in 2017.11 Those temporary changes also
significantly reduced the effective tax rates for business investment as wel . In general, the
current effective tax rate on the return to owner-occupied housing is similar to the rate on
business investment, although it wil be favored compared to business under permanent rules.12
those who itemize. Tax cuts enacted in 2017 (P.L. 115-97) and extended and enhanced in 2025 (P.L. 119-21) narrowed the gap between the tax treatment of business income and owner-occupied housing by reducing taxes on investments and limiting itemizers. For assets excluding land and inventories, investments in the business sector were taxed at an effective rate of 18.1% and investments in owner-occupied housing at -9.5%. Under current law these rates are 9.0% and -0.09%.¹³ Housing is often claimed to provide other benefits that justify favorable treatment, although such Housing is often claimed to provide other benefits that justify favorable treatment, although such
benefits have not benefits have not general ygenerally been measured. been measured.13
14 It is not clear whether the prospect of future capital gains relief plays an important role in It is not clear whether the prospect of future capital gains relief plays an important role in
inducing additional investment in housing. Unlike mortgage interest deductions, future capital

11 T hree provisions in the 2017 legislation (P.L. 115-97) reduced the benefit of itemized deductions: (1) an increase in
the standard deduction that made itemizing less beneficial, (2) a cap on state and local taxes of $10,000, and (3) a
reduction in the mortgage interest deduction allowed from that on $1 million of indebtedness to $ 500,000. These
provisions apply through 2025. T here is a permanent limit on interest deduction for indebtedness up to $1 million,
which was enacted in 1987.
12 See T able 9 in CRS Report RL34229, Corporate Tax Reform: Issues for Congress, by Jane G. Gravelle.
13 See CRS In Focus IF11305, Why Subsidize Homeownership? A Review of the Rationales, by Mark P. Keightley for a
discussion.
Congressional Research Service

6

---

link to page 13 link to page 13 The Exclusion of Capital Gains for Owner-Occupied Housing

inducing additional investment in housing. Unlike mortgage interest deductions, future capital gains relief provides no immediate cash flow benefit, and may be heavily discounted due to the gains relief provides no immediate cash flow benefit, and may be heavily discounted due to the
delay and uncertainty of the benefit.delay and uncertainty of the benefit.
In addition, there are In addition, there are some good reasons to provideseveral policy arguments that may support providing some relief for capital gains on owner- some relief for capital gains on owner-
occupied houses and occupied houses and to restrictrestricting other owner-occupied housing tax benefits if a reduction in the other owner-occupied housing tax benefits if a reduction in the
preferential treatment of owner-occupied housing is desired. preferential treatment of owner-occupied housing is desired. Perhaps the most important of these
justificationsAmong the rationales offered for relief is for relief is tothat it may reduce the barriers to labor mobility, reduce the barriers to labor mobility, potentially contributing to economic contributing to economic
efficiency. Other reasons include reduction in other inefficiencies that distort housing costs; more efficiency. Other reasons include reduction in other inefficiencies that distort housing costs; more
equitable treatment among homeowners in different circumstances; and reduction of compliance equitable treatment among homeowners in different circumstances; and reduction of compliance
burdens. Empirical evidence suggestsburdens. Some empirical studies suggest that significant distortions are induced by the gains tax that significant distortions are induced by the gains tax
once an individualonce an individual has a home and wishes to move.has a home and wishes to move.14
15 In contrast, the exclusion can contribute to compliance problems, by In contrast, the exclusion can contribute to compliance problems, by al owingallowing a potential for tax a potential for tax
sheltering. These tax sheltering problems are discussed below in the sheltering. These tax sheltering problems are discussed below in the "“Contribution of Provision to
Tax Sheltering and Avoidance” " section.section.
The possible forms of capital gains revisions are closely tied to these rationales and issues. The possible forms of capital gains revisions are closely tied to these rationales and issues.
Therefore, following the general discussion of the rationales, this report also considers the Therefore, following the general discussion of the rationales, this report also considers the
implications of the particular forms of these potential changes.implications of the particular forms of these potential changes.
Labor Mobility
One of the One of the important reasons for having some type of relief is to minimize the barriers to labor reasons for having some type of relief is to minimize the barriers to labor
mobility. To have an efficient market economy that can respond to changes in tastes and mobility. To have an efficient market economy that can respond to changes in tastes and
technology, it is imperative to have as few barriers to labor mobility as possible. This technology, it is imperative to have as few barriers to labor mobility as possible. This
consideration was reflected in the rationale for the rollover provision enacted in 1951. Americansconsideration was reflected in the rationale for the rollover provision enacted in 1951. Americans' ’
taste and preference for owning their own homes inevitably creates barriers to a taste and preference for owning their own homes inevitably creates barriers to a wil ingnesswillingness to to
relocate, barriers that cannot be avoided. Imposing capital gains tax at sale adds to that barrier.relocate, barriers that cannot be avoided. Imposing capital gains tax at sale adds to that barrier.
The rollover provision, as it existed in prior law, provided some relief but The rollover provision, as it existed in prior law, provided some relief but stil still left some barriers left some barriers
to mobility in place. One problem arose because of regional differences in housing prices, which to mobility in place. One problem arose because of regional differences in housing prices, which
stil still exist. If the individualexist. If the individual was moving to an area that was moving to an area that general ygenerally has lower prices (e.g., from has lower prices (e.g., from
California to Arizona), it might be sensible to buy a house that was similar in quality but cost less California to Arizona), it might be sensible to buy a house that was similar in quality but cost less
because of lower because of lower overal overall area prices (which might also have included a lower salary). This shift area prices (which might also have included a lower salary). This shift
would result in a capital gain, and the individualwould result in a capital gain, and the individual then might have been discouraged from making then might have been discouraged from making
the move or induced to purchase a larger house than otherwise desirable. Circumstances where it the move or induced to purchase a larger house than otherwise desirable. Circumstances where it
might have been more desirable to rent rather than to purchase a new home when relocating may might have been more desirable to rent rather than to purchase a new home when relocating may
also have existed (e.g., when the family is moving because of economic hardship or the new also have existed (e.g., when the family is moving because of economic hardship or the new
location is expected to be the place of employment for only a few years). The rollover provision location is expected to be the place of employment for only a few years). The rollover provision
would not have reduced the capital gains barrier in that case. Thus, the rollover provision was would not have reduced the capital gains barrier in that case. Thus, the rollover provision was
imperfect in its eliminationimperfect in its elimination of labor mobility barriers.of labor mobility barriers.
The capped exclusion eliminates The capped exclusion eliminates al all barriers, as long as the cap is not exceeded, and reduces the barriers, as long as the cap is not exceeded, and reduces the
cost of labor mobility. Unless the cap is increased explicitly or indexed to housing prices, cost of labor mobility. Unless the cap is increased explicitly or indexed to housing prices,
however, an increasing share of individuals however, an increasing share of individuals wil will be affected by the ceiling over time and barriers be affected by the ceiling over time and barriers
to labor mobility wil grow.

14 Leonard E. Burman, Sally Wallace, and David Weiner, “How Capital Gains T axes Distort Homeowners’ Decisions,”
Proceedings of the 89th Annual Conference on Taxation of the National Tax Association (Washington, DC: National
T ax Association, 1997), pp. 382-390.
Congressional Research Service

7

---

The Exclusion of Capital Gains for Owner-Occupied Housing

Other Distortions
to labor mobility will grow. Other Distortions Aside from the labor mobility Aside from the labor mobility problemissue, capital gains taxes on owner-occupied housing can cause , capital gains taxes on owner-occupied housing can cause
other distortions. Capital gains taxes on assets in general cause a lock-in effect (i.e., discourage other distortions. Capital gains taxes on assets in general cause a lock-in effect (i.e., discourage
changes in portfolio changes in portfolio al ocationsallocations by replacing old assets with new assets). That the lock-in effect by replacing old assets with new assets). That the lock-in effect
for homes in particular may impose greater costs. Financial assets are more likely to be close for homes in particular may impose greater costs. Financial assets are more likely to be close
substitutes, so the lock-in effect is probably not very costly. (However, it is also possible to swap substitutes, so the lock-in effect is probably not very costly. (However, it is also possible to swap
real estate investments without paying a capital gains tax via a 1031 exchange.) Some might real estate investments without paying a capital gains tax via a 1031 exchange.) Some might
argue that people should be encouraged to hold on to investments in the stock market for a long argue that people should be encouraged to hold on to investments in the stock market for a long
period of time, in order to average out the ups and downs of the market, and the lock-in effect period of time, in order to average out the ups and downs of the market, and the lock-in effect
may actual ymay actually be beneficial in some cases. be beneficial in some cases.
Different types of housing, however, may be less substitutable for each other; the difference Different types of housing, however, may be less substitutable for each other; the difference
between the house to which an owner is between the house to which an owner is “"locked-inlocked-in”" and the home he desires may be more and the home he desires may be more
important than for various alternative financial assets. And with no relief provisions, capital gains important than for various alternative financial assets. And with no relief provisions, capital gains
taxes discourage moving, whether to a larger house (e.g., to accommodate a larger family) or a taxes discourage moving, whether to a larger house (e.g., to accommodate a larger family) or a
smal ersmaller one (when children have grown and left the home or to simplify maintenance during one (when children have grown and left the home or to simplify maintenance during
retirement). As noted above, a rollover treatment can cause people to buy too much housing or retirement). As noted above, a rollover treatment can cause people to buy too much housing or
continue to own when renting might be optimal. The once-in-a-lifetime exclusion that aided the continue to own when renting might be optimal. The once-in-a-lifetime exclusion that aided the
elderly was aimed at older individuals who might wish to elderly was aimed at older individuals who might wish to sel sell their houses to move into their houses to move into smal er
smaller and more easily maintained houses, to move to a rental status, or to and more easily maintained houses, to move to a rental status, or to “"cash outcash out”" the value of the the value of the
house for other purposes. If the exclusion cap does not come into play, these distortions do not house for other purposes. If the exclusion cap does not come into play, these distortions do not
exist, but, as noted above, if the cap does not rise with housing prices it exist, but, as noted above, if the cap does not rise with housing prices it wil will become increasingly become increasingly
binding.binding.
The current provision permitting a capped exclusion every two years The current provision permitting a capped exclusion every two years actual yactually creates, for those creates, for those
affected, the opposite distortion. It favors higher-income individuals who move more frequently. affected, the opposite distortion. It favors higher-income individuals who move more frequently.
For instance, an individual who has a capital gain at the limitFor instance, an individual who has a capital gain at the limit can move, take advantage of the can move, take advantage of the
gains exclusion, and then, within, two years take advantage of it again, while the individualgains exclusion, and then, within, two years take advantage of it again, while the individual who
sel s who sells only once, but has an equal gain would have to pay tax. Suppose, for example, that one only once, but has an equal gain would have to pay tax. Suppose, for example, that one
taxpayer (a single individual)taxpayer (a single individual) realizes a capital gain of $200,000 on the sale of a home, purchases realizes a capital gain of $200,000 on the sale of a home, purchases
another home, and then another home, and then sel ssells that second home two years later, earning an additional $200,000 in that second home two years later, earning an additional $200,000 in
capital gains. The taxpayer would be able to exclude $400,000. If a similar taxpayer experiences a capital gains. The taxpayer would be able to exclude $400,000. If a similar taxpayer experiences a
single gain of $400,000 in the same time period, he or she may exclude only $250,000. Of course, single gain of $400,000 in the same time period, he or she may exclude only $250,000. Of course,
any tax benefits from moving more often may have little effect on behavior, given the any tax benefits from moving more often may have little effect on behavior, given the
transactions costs and general burdens of changing residences.transactions costs and general burdens of changing residences.
Equity Issues
The caps on both the prior one-time exclusion and the current exclusion were enacted to impose The caps on both the prior one-time exclusion and the current exclusion were enacted to impose
gains taxes on higher-income individuals with large capital gains, and therefore the caps are gains taxes on higher-income individuals with large capital gains, and therefore the caps are
presumed to have a vertical equity objective because they limit the benefit for high-income presumed to have a vertical equity objective because they limit the benefit for high-income
taxpayers.taxpayers.
The cap, however, The cap, however, producescan also be seen as producing some horizontal inequities. First, the limited exclusion combined some horizontal inequities. First, the limited exclusion combined
with the step-up in basis at death causes with the step-up in basis at death causes elderlyolder taxpayers who had to move from their homes due taxpayers who had to move from their homes due
to il to ill health to pay taxes not assessed on their healthier counterparts who remain in their homes health to pay taxes not assessed on their healthier counterparts who remain in their homes
until their death and leave the houses to their heirs with no capital gains tax.until their death and leave the houses to their heirs with no capital gains tax.
The cap itself also produces some inequities among individuals who The cap itself also produces some inequities among individuals who sel sell their homes and who are their homes and who are
affected by the cap. These inequities are of three types: (1) between those who move frequently affected by the cap. These inequities are of three types: (1) between those who move frequently
and those who do not; (2) between people living in different regions of the country; and (3) and those who do not; (2) between people living in different regions of the country; and (3)
Congressional Research Service

8

---

The Exclusion of Capital Gains for Owner-Occupied Housing

between married couples in which both spouses survive until the point they wish to between married couples in which both spouses survive until the point they wish to sel sell and those and those
in which only one spouse survives.in which only one spouse survives.
In the first case, people who buy and In the first case, people who buy and sel sell frequently (and are thus less likelyfrequently (and are thus less likely to accrue a large gain to accrue a large gain
in a particular sale) are less likelyin a particular sale) are less likely to be affected by the tax. For example, a married couple who to be affected by the tax. For example, a married couple who
sel ssells every five years and gets a $150,000 gain on each sale would not pay a gains tax. If a similar every five years and gets a $150,000 gain on each sale would not pay a gains tax. If a similar
couple buys a house and couple buys a house and sel ssells after 20 years with the same accumulated gain (four times $150,000 after 20 years with the same accumulated gain (four times $150,000
or $600,000), they or $600,000), they wil will pay a tax.pay a tax.
Taxpayers living in states and locations where the cost of living, including housing prices, tends Taxpayers living in states and locations where the cost of living, including housing prices, tends
to be high, are more likelyto be high, are more likely to be affected by the cap even in cases where their real incomes and to be affected by the cap even in cases where their real incomes and
standard of living are the same as those who are not affected. For example, taxpayers in standard of living are the same as those who are not affected. For example, taxpayers in
California and Massachusetts are more likely to be affected than taxpayers in Mississippi and California and Massachusetts are more likely to be affected than taxpayers in Mississippi and
Oklahoma.Oklahoma.
Final y In addition, the tax is more likely to , the tax is more likely to fal fall on elderly taxpayers who have lost a spouse than married on elderly taxpayers who have lost a spouse than married
couples who remain alive at the time they wish to couples who remain alive at the time they wish to sel sell their house. Although the tax laws their house. Although the tax laws al ow
allow the gain for the spouse who is deceased to be excluded (half the gain at that time), further capital the gain for the spouse who is deceased to be excluded (half the gain at that time), further capital
gain exclusions are limited by the lower ceiling that applies to singles.gain exclusions are limited by the lower ceiling that applies to singles.1516 For example, suppose the For example, suppose the
gain on a house is $400,000. In the case of a married couple who gain on a house is $400,000. In the case of a married couple who sel ssells, the entire gain , the entire gain wil will be be
excluded. In the case of a surviving spouse, the exclusion excluded. In the case of a surviving spouse, the exclusion wil will be $250,000 plus half of any gain be $250,000 plus half of any gain
that accrued during the deceased spousethat accrued during the deceased spouse’'s life; if that gain is less than $150,000 some tax s life; if that gain is less than $150,000 some tax wil be
will be due. Because most women marry men who are older than they are, and because women live due. Because most women marry men who are older than they are, and because women live
longer than men, a significant number of widows are likely to live in the house after the spouse longer than men, a significant number of widows are likely to live in the house after the spouse
has died.has died.
Recordkeeping
Recordkeeping required to deal with the capital gains tax on residences is complex. To comply Recordkeeping required to deal with the capital gains tax on residences is complex. To comply
with tax regulations, taxpayers have had to keep detailed records of the financial expenditures with tax regulations, taxpayers have had to keep detailed records of the financial expenditures
associated with their home ownership. The taxpayer needs to record the original cost of the associated with their home ownership. The taxpayer needs to record the original cost of the
residence, any costs added at the time of purchase, and any capital improvements. In the latter residence, any costs added at the time of purchase, and any capital improvements. In the latter
case, taxpayers also have had to differentiate between those expenditures that affected the basis of case, taxpayers also have had to differentiate between those expenditures that affected the basis of
the property and those that were merely for maintenance or repairs.the property and those that were merely for maintenance or repairs.1617 In many instances, these In many instances, these

15 If a surviving spouse and the decedent owned the home jointly, the basis in the home changes after the death of the
decedent. T he new basis for the half interest that the decedent owned will be one-half of the fair market value on the
date of death (or alternate valuation date). For example, suppose a couple jointly owned a home that had an adjusted
basis of $100,000 on the date of one spouse’s death. T he fair market value on that date was $200,000. T he new basis in
the home is $150,000 ($50,000 for one-half of the adjusted basis plus $100,000 for one-half of the fair market value).
16 Calculating capital gains requires a measure of basis. A taxpayer’s basis in real estate is cost (or fair market value if
acquired by inheritance). T he cost of property is the amount paid for it in cash, debt obligations, other property, or
services, which can include the purchase price and certain settlement or closing costs. When calculating the gain or loss
on the sale of a residence, the basis is adjusted for changes made since the acquisition of the property. Increases to basis
include the cost of capital improvements, such as air conditioning or a new roof; special assessments for local
improvements; and any other additions that have a useful life of more than one year. Examples of decreases to basis
include any capital gain that was postponed from the sale of a previous home before May 7, 1997; deductible casualty
losses or insurance payments received for casualty losses; payments received for granting an easement or ri ght-of-way;
depreciation allowed if the home was used for business or rental purposes; a first -time homebuyer credit (allowed to
certain first -time buyers of a home in the District of Columbia); and energy conservation subsidy excluded from gross
income because it was received to buy or install any energy conservation measure.
Congressional Research Service

9

---

link to page 4 The Exclusion of Capital Gains for Owner-Occupied Housing

records have to be kept for decades. Congress has addressed this issue, stating in the reasons for
records have to be kept for decades. Congress has addressed this issue, stating in the reasons for the 1997 increase in the exclusion thatthe 1997 increase in the exclusion that
calculating capital gain from the sale of a principal residence was among the most complex calculating capital gain from the sale of a principal residence was among the most complex
tasks faced by a typical taxpayer.... [A]s a result of the rollover provisions and the $125,000 tasks faced by a typical taxpayer.... [A]s a result of the rollover provisions and the $125,000
one-time exclusion under prior law, detailed records of transactions and expenditures on one-time exclusion under prior law, detailed records of transactions and expenditures on
home improvements had to be kept, in most cases, for many decades.home improvements had to be kept, in most cases, for many decades.17
18 The 1997 tax law simplified income tax administration and record keeping by providing a The 1997 tax law simplified income tax administration and record keeping by providing a
“"relatively high threshold, few taxpayers relatively high threshold, few taxpayers wil will have to refer to records in determining income tax have to refer to records in determining income tax
consequences of transactions related to their house.consequences of transactions related to their house.”18
"¹⁹ The capital gains exclusion, however, was not indexed for inflation or for housing price The capital gains exclusion, however, was not indexed for inflation or for housing price c hanges.
The average of existing home sales has increased by 151% since 1997 and the median price has
increased even more. As noted in the “Introduction”, if the $500,000 ($250,000) values had been
increased to reflect the average housing price, they would be approximately $1,300,000
($650,000); if they had been increased to reflect the median housing price by 2021, they would be
$1,400,000 ($700,000).19 If they had been increased to reflect the general price rise in the
economy (the GDP deflator), they would be $800,000 ($400,000).20changes. In addition, gain on houses In addition, gain on houses
increased increased proportional yproportionally more. For example, if the basis (the original cost) of the house in 1997 more. For example, if the basis (the original cost) of the house in 1997
were half the market value purchase price, a 150% increase in value would mean a 300% increase were half the market value purchase price, a 150% increase in value would mean a 300% increase
in the gain. This appreciation means that many more taxpayers would be subject to the ceiling. in the gain. This appreciation means that many more taxpayers would be subject to the ceiling.
Without an indexing procedure, some of the potential recordkeeping benefits from the 1997 Without an indexing procedure, some of the potential recordkeeping benefits from the 1997
revision have been lost. It would be unwise for many taxpayers to abandon recordkeeping given revision have been lost. It would be unwise for many taxpayers to abandon recordkeeping given
that the exclusion is covering fewer and fewer sales over time and there is no commitment from that the exclusion is covering fewer and fewer sales over time and there is no commitment from
the government to index the provision, so that the simplification from less recordkeeping is likely the government to index the provision, so that the simplification from less recordkeeping is likely
to be diminished.to be diminished.
Contribution of Provision to Tax Sheltering and Avoidance
The presence of a special exclusion contributes to the possibility of using the tax benefit to avoid The presence of a special exclusion contributes to the possibility of using the tax benefit to avoid
capital gains taxes in unintended ways. This section discusses several ways this might occur.capital gains taxes in unintended ways. This section discusses several ways this might occur.
Converting Rental Property to Owner-Occupied Property
Capital gains avoidance can occur by converting rental property to owner-occupied property. Capital gains avoidance can occur by converting rental property to owner-occupied property.
After this conversion, the property can be sold and the capital gains excluded up to the After this conversion, the property can be sold and the capital gains excluded up to the al owable
allowable amount, as long as the property has been owned and used as a principal residence for at least two amount, as long as the property has been owned and used as a principal residence for at least two
years during the five-year period ending on the date of the sale of the residence. For example, years during the five-year period ending on the date of the sale of the residence. For example,
consider a married couple who have a primary residence and a rental property and both properties consider a married couple who have a primary residence and a rental property and both properties
have substantial yhave substantially appreciated in value. The couple can appreciated in value. The couple can sel sell the primary residence and claim a the primary residence and claim a
capital gain exclusion of up to $500,000 on that residence. The couple can then move into the

17 U.S. Congress, Joint Committee on T axation, General Explanation of Tax Legislation Enacted in 1997 , 105th Cong.,
1st sess. (Washington: GPO, 1997), pp. 54-55.
18 U.S. Congress, Joint Committee on T axation, General Explanation of Tax Legislation Enacted in 1997 , 105th Cong.,
1st sess. (Washington: GPO, 1997), pp. 54-55.
19 For average and median house prices, see FRED Economic Data, Average Prices of Houses Sold for the United
States, https://fred.stlouisfed.org/series/ASPUS and Median Sales Price of Houses Sold for the United States,
https://fred.stlouisfed.org/series/MSPUS.
20 See Bureau of Economic Analysis, National Income and Product Accounts, T able 1.1.4, https://apps.bea.gov/iTable/
iT able.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey.
Congressional Research Service

10

---

The Exclusion of Capital Gains for Owner-Occupied Housing

capital gain exclusion of up to $500,000 on that residence. The couple can then move into the rental property and use that as the primary residence. After two years the taxpayers could then rental property and use that as the primary residence. After two years the taxpayers could then sel
sell the property and realize a gain of which up to $500,000 can be excluded under the law. It makes the property and realize a gain of which up to $500,000 can be excluded under the law. It makes
no difference that most of the appreciation on the second property was realized when it was a no difference that most of the appreciation on the second property was realized when it was a
rental unit. Current tax law, however, does require that any depreciation on the rental property be rental unit. Current tax law, however, does require that any depreciation on the rental property be
recaptured and taxedrecaptured and taxed.21
as ordinary income with a cap of a 25% rate.²⁰ An example of the depreciation recapture can be seen in the following example. A married couple An example of the depreciation recapture can be seen in the following example. A married couple
sel ssells their primary residence which had an adjusted basis (purchase price plus capital their primary residence which had an adjusted basis (purchase price plus capital
improvements) of $100,000 for $200,000. In prior years, the property had been a rental property improvements) of $100,000 for $200,000. In prior years, the property had been a rental property
and the couple had claimed $50,000 in depreciation deductions on the home. The taxable gain for and the couple had claimed $50,000 in depreciation deductions on the home. The taxable gain for
the sale would be $100,000, which is the sales price minus the adjusted basis. Of that gain, the sale would be $100,000, which is the sales price minus the adjusted basis. Of that gain,
$50,000 is tax-free and the $50,000 taken as depreciation deductions in the past would be subject $50,000 is tax-free and the $50,000 taken as depreciation deductions in the past would be subject
to a 25% capital gains tax.to a 25% capital gains tax.
“"Like-Kind”" Property Exchanges
Taxpayers can avoid paying tax on the gain from the sale of their real estate property by Taxpayers can avoid paying tax on the gain from the sale of their real estate property by
participating in a participating in a “"like-kindlike-kind”" property exchange. Under section 1031 of the Internal Revenue property exchange. Under section 1031 of the Internal Revenue
Code, like-property exchanges offer business owners or investors a way to trade their property for Code, like-property exchanges offer business owners or investors a way to trade their property for
something of similar value and type without reporting a profit and, thereby, defer paying taxes on something of similar value and type without reporting a profit and, thereby, defer paying taxes on
the gain. In the case of residential property, this exchange can be combined with the exclusion of the gain. In the case of residential property, this exchange can be combined with the exclusion of
capital gains to capital gains to al owallow taxpayers to avoid capital gains tax on some of the deferred gain. Some taxpayers to avoid capital gains tax on some of the deferred gain. Some
gain on the original investment property would be taxed as recaptured depreciation, and some gain on the original investment property would be taxed as recaptured depreciation, and some
may be taxed if the total remaining gain exceeds the cap. For example, a taxpayer who owns a may be taxed if the total remaining gain exceeds the cap. For example, a taxpayer who owns a
rental property can participate in a like-kind exchange for another residential property, which then rental property can participate in a like-kind exchange for another residential property, which then
becomes the taxpayerbecomes the taxpayer’'s primary residence. The taxpayer must meet the ownership and use tests s primary residence. The taxpayer must meet the ownership and use tests
for a minimum of five years before the taxpayer can then for a minimum of five years before the taxpayer can then sel sell the property and exclude capital the property and exclude capital
gains up to the gains up to the al owableallowable amount. amount. Essential yEssentially, the taxpayer , the taxpayer wil will have sold real estate and avoided have sold real estate and avoided
capital gains taxation on some, and perhaps most, of the capital gains earned on both properties.capital gains taxation on some, and perhaps most, of the capital gains earned on both properties.
Prior to October 2004 when the American Jobs Creation Act of 2004 (P.L. 108-357) was enacted, Prior to October 2004 when the American Jobs Creation Act of 2004 (P.L. 108-357) was enacted,
there was no minimum holding period for properties acquired through like-kind exchanges. The there was no minimum holding period for properties acquired through like-kind exchanges. The
exclusion of gain on the sale of a principal residence applied after two years, when the ownership exclusion of gain on the sale of a principal residence applied after two years, when the ownership
and use tests for the provision would have been met. The 2004 law requires the taxpayer to hold and use tests for the provision would have been met. The 2004 law requires the taxpayer to hold
the exchanged property for a full five years, as opposed to two, before the residence can qualify the exchanged property for a full five years, as opposed to two, before the residence can qualify
as a principal residence. This change reduced, but did not eliminate, the attractiveness of as a principal residence. This change reduced, but did not eliminate, the attractiveness of
combining like-kind exchanges with the principal residence exclusion.combining like-kind exchanges with the principal residence exclusion.22
21 Sharing Capital Gains
If taxpayers expect huge gains from owning, then If taxpayers expect huge gains from owning, then sel ingselling a house—more than can be excluded a house—more than can be excluded
from tax under the new rule—they could divide ownership of the house to maximize the amount from tax under the new rule—they could divide ownership of the house to maximize the amount
of capital gain that could be excluded. If, for example, a married couple owns their residence of capital gain that could be excluded. If, for example, a married couple owns their residence
together with an adult son and he meets the ownership and use tests for one-third of the property, together with an adult son and he meets the ownership and use tests for one-third of the property,
the son may the son may sel sell his share for a $250,000 gain without incurring a tax. His parents could his share for a $250,000 gain without incurring a tax. His parents could
simultaneously simultaneously sel sell their share for $500,000 without tax, sheltering as much as $750,000 in their share for $500,000 without tax, sheltering as much as $750,000 in
capital gains. Note that this avoidance technique arises not from the exclusion, but from the capital gains. Note that this avoidance technique arises not from the exclusion, but from the

21 T he recapture rule, enacted by the T axpayer Relief Act of 1997, applies to depreciation claimed after May 6, 1997.
Any depreciation taken before that date is “ forgiven” and not recaptured.
22 More information available in CRS Report RS22113, The Sale of a Principal Residence Acquired Through a Like-
Kind Exchange, by Gregg A. Esenwein (out of print but available to congressional staff from the author).
Congressional Research Service

11

---

The Exclusion of Capital Gains for Owner-Occupied Housing

presence of a cap. This approach to tax avoidance involves some constraints and risks: the child presence of a cap. This approach to tax avoidance involves some constraints and risks: the child
must live in the residence, and the property could be subject to attachment for the childmust live in the residence, and the property could be subject to attachment for the child’'s debts.s debts.
Including Investment Property with the Home
This avoidance technique might be termed the This avoidance technique might be termed the “"land with a land with a smal house”small house" strategy. A taxpayer can strategy. A taxpayer can
purchase a house with a significant amount of land as an investment, and then use the exclusion purchase a house with a significant amount of land as an investment, and then use the exclusion
for the residence to also exclude gain on the land. A taxpayer can also for the residence to also exclude gain on the land. A taxpayer can also sel sell vacant land adjacent to vacant land adjacent to
your home separately from the home itself, as long as the home is also sold either two years your home separately from the home itself, as long as the home is also sold either two years
before or two years after the sale of the vacant land. There are some restrictions on this exclusion before or two years after the sale of the vacant land. There are some restrictions on this exclusion
for land, one being that the land must not only be adjacent to the home but used as part of the for land, one being that the land must not only be adjacent to the home but used as part of the
home (which would rule out farm land, timber land, and other uses but not simple speculation).home (which would rule out farm land, timber land, and other uses but not simple speculation).
The Professional “"Fixer-Upper”
" An individualAn individual can buy a house that needs substantial renovation as a principal residence, fix it up, can buy a house that needs substantial renovation as a principal residence, fix it up,
live in it for two years, and then live in it for two years, and then sel sell the home. This gain reflects untaxed labor income of the the home. This gain reflects untaxed labor income of the
individual,individual, which is now excluded from tax. In fact, this approach can be used by professional which is now excluded from tax. In fact, this approach can be used by professional
builders who would builders who would normal ynormally be paid for their services. be paid for their services.
Cottage and Home
An individualAn individual who has both a regular home and a vacation home can take measures to shift the who has both a regular home and a vacation home can take measures to shift the
vacation home to principal residence status. Such an individual may effectively continue to live in vacation home to principal residence status. Such an individual may effectively continue to live in
the original home in part, but after the required holding period can the original home in part, but after the required holding period can sel sell the vacation home, avoid the vacation home, avoid
capital gains, and move back to the regular home as a permanent residence. Which home is capital gains, and move back to the regular home as a permanent residence. Which home is
determined to be the principal residence is based on a facts and circumstances assessment, determined to be the principal residence is based on a facts and circumstances assessment,
including the length of time the taxpayer lives in each home, the location of employment and the including the length of time the taxpayer lives in each home, the location of employment and the
principal residences of family members, mailing addresses (on principal residences of family members, mailing addresses (on bil sbills and correspondence, tax and correspondence, tax
returns, driversreturns, drivers’' licenses, and car and voter registrations), the locations of banks used, and the licenses, and car and voter registrations), the locations of banks used, and the
location of recreational associations and churches where the taxpayer has a membership. Thus, it location of recreational associations and churches where the taxpayer has a membership. Thus, it
is not easy to establish the vacation home as the principal residence, though it may be feasible in is not easy to establish the vacation home as the principal residence, though it may be feasible in
some cases and, of course, the Internal Revenue Service cannot audit every case of this type.some cases and, of course, the Internal Revenue Service cannot audit every case of this type.
House Swapping
In this avoidance technique, wealthy individuals In this avoidance technique, wealthy individuals sel sell their homes back and forth their homes back and forth periodical yperiodically to to
qualify frequently for the capital gains tax exclusion. If they qualify frequently for the capital gains tax exclusion. If they mutual ymutually agree to this arrangement, agree to this arrangement,
the transactions costs could be minimal (i.e., a lawyer to search the title and record the the transactions costs could be minimal (i.e., a lawyer to search the title and record the
transaction). They may not even live in the exchanged homes. Such an arrangement is transaction). They may not even live in the exchanged homes. Such an arrangement is il egalillegal (a (a
sham transaction) but may be difficult to detect. This avoidance technique arises from the sham transaction) but may be difficult to detect. This avoidance technique arises from the
existence of the cap.existence of the cap.
Options for Change
Although numerous potential ways exist to deal with capital gains taxes on owner-occupied Although numerous potential ways exist to deal with capital gains taxes on owner-occupied
housing, including retaining the current rules or returning to the pre-1997 rules, two areas where housing, including retaining the current rules or returning to the pre-1997 rules, two areas where
changes might be considered are the ceilings on the exclusion and in rules relating to investment changes might be considered are the ceilings on the exclusion and in rules relating to investment
property and tax sheltering.property and tax sheltering.
Congressional Research Service

12

---

The Exclusion of Capital Gains for Owner-Occupied Housing

Options for addressing the ceilings could include eliminatingOptions for addressing the ceilings could include eliminating the ceilings altogether, indexing the the ceilings altogether, indexing the
ceilings either with respect to general inflation or housing prices, changing the relative ceilings ceilings either with respect to general inflation or housing prices, changing the relative ceilings
between single and joint returns, or changing the basic structure of the ceilings.between single and joint returns, or changing the basic structure of the ceilings.
Eliminating the Ceilings
One policy option could be to remove the ceilings altogether. For some taxpayers, the exclusion One policy option could be to remove the ceilings altogether. For some taxpayers, the exclusion
with ceilings enacted in 1997 increases their tax liability,with ceilings enacted in 1997 increases their tax liability, because they might otherwise have used because they might otherwise have used
the rollover provision and then held the asset until death.the rollover provision and then held the asset until death.
One advantage of eliminating the ceilings would be the eliminationOne advantage of eliminating the ceilings would be the elimination of any remaining distortions of any remaining distortions
(such as incentives not to (such as incentives not to sel sell a house even if it would be desirable) and recordkeeping a house even if it would be desirable) and recordkeeping
requirements. This efficiency gain would reflect not only benefits to high-income individuals who requirements. This efficiency gain would reflect not only benefits to high-income individuals who
actual yactually pay the tax, but also the much larger group who, because of uncertainty, need to keep pay the tax, but also the much larger group who, because of uncertainty, need to keep
records. As the discussion above on indexing indicates, by one index, houses have, on average,
increased in value by 160% in the 24 years since the existing ceilings were imposed.23 Suppose in
1997 a married couple had a home worth $300,000 with a $200,000 gain. A 160% increase would
have caused the new home value to rise to $780,000 for a $680,000 gain. The gain would have
more than tripled and would exceed the limit of $500,000.
records. Other circumstances could cause such a taxpayer to be over the limit. The percentage gain figure Other circumstances could cause such a taxpayer to be over the limit. The percentage gain figure
cited above is averaged across the country. In several cities across the country, including some in cited above is averaged across the country. In several cities across the country, including some in
California, the average value of houses has increased more quickly. Another circumstance in California, the average value of houses has increased more quickly. Another circumstance in
which the ceiling would be exceeded is if a spouse dies before most of the additional appreciation which the ceiling would be exceeded is if a spouse dies before most of the additional appreciation
occurs. In that case, the surviving spouse could be over the exclusion limit because the exclusion occurs. In that case, the surviving spouse could be over the exclusion limit because the exclusion
would be limitedwould be limited to about $350,000 ($100,000 for half the appreciation that had already occurred to about $350,000 ($100,000 for half the appreciation that had already occurred
and the $250,000 limit for single individuals). and the $250,000 limit for single individuals). Final yFinally, while some individuals , while some individuals sel sell houses more houses more
frequently, others live in them for a very long time. These examples frequently, others live in them for a very long time. These examples il ustrateillustrate that individuals who that individuals who
are livingare living in houses that may currently have accrued gains or have values in houses that may currently have accrued gains or have values wel well below the limitbelow the limit on on
the capital gains exclusion would need to keep records given the uncertainty about how long the the capital gains exclusion would need to keep records given the uncertainty about how long the
house house wil will be owned, what the appreciation rate be owned, what the appreciation rate wil will be, whether and when Congress might act to be, whether and when Congress might act to
change the ceiling, and whether a spouse might die.change the ceiling, and whether a spouse might die.
Eliminating Eliminating the ceilings would also eliminatethe ceilings would also eliminate the inequities that arise among homeowners. These the inequities that arise among homeowners. These
inequities tend to arise because of differences in housing prices across states and localities, inequities tend to arise because of differences in housing prices across states and localities,
differences that lead to more or less frequent sales of houses, and differences among elderly differences that lead to more or less frequent sales of houses, and differences among elderly
homeowners that arise from different health outcomes that require the sale of a house.homeowners that arise from different health outcomes that require the sale of a house.
Eliminating Eliminating the ceilings has some disadvantages. It would involve a revenue loss. In addition, the ceilings has some disadvantages. It would involve a revenue loss. In addition,
some people might see its expected favoritism of high-income individuals to be a disadvantage. some people might see its expected favoritism of high-income individuals to be a disadvantage.
Any reduction in tax progressivity, however, would be minor. The revenue loss from eliminating Any reduction in tax progressivity, however, would be minor. The revenue loss from eliminating
the ceilings is relatively minor in comparison to the revenue loss for the exclusion in general and the ceilings is relatively minor in comparison to the revenue loss for the exclusion in general and
the taxes collected on other assets of highthe taxes collected on other assets of high -income individuals. As estimated above, the cost of income individuals. As estimated above, the cost of
eliminating eliminating the ceiling is the ceiling is about $6 bil ion. expected to be several billion dollars. This amount is This amount is smal small relative to the capital gains taxes relative to the capital gains taxes
paid by high-income individuals. For example, paid by high-income individuals. For example, an estimate for the taxes paid onCBO estimates that $261 billion was paid in capital gains taxes in FY2025; most of this tax is paid by high-income individuals.²² It is also small capital gains and
qualified dividends for individuals with $200,000 or more of income was $390 bil ion for 2021;
based on data from Internal Revenue Service Statistics, about $316 bil ion of that was on capital

23 FRED Economic Data, Average Prices of Houses Sold for the United States, https://fred.stlouisfed.org/series/
ASPUS.
Congressional Research Service

13

---

The Exclusion of Capital Gains for Owner-Occupied Housing

gains.24 It is also smal compared with total income taxes, with taxes paid by those with $200,000 compared with total income taxes, with taxes paid by those with $200,000
or more in income estimated at $or more in income estimated at $1,598 bil ion.2,092 billion for 2025.²³ Thus, while the taxes paid above the exclusion are Thus, while the taxes paid above the exclusion are
concentrated in higher-income families, they are concentrated in higher-income families, they are smal small compared with compared with overal overall taxes on capital taxes on capital
gains or gains or al all taxes paid by high-income individuals.taxes paid by high-income individuals.25
For example, in 1999,For example, in 1999,2624 reported taxable capital gains on the sales of residences were in the range reported taxable capital gains on the sales of residences were in the range
of $3.7 of $3.7 bil ion billion to $4.9 to $4.9 bil ion.27billion.²⁵ Assuming a 20% tax rate, the tax on this amount was less than $1 Assuming a 20% tax rate, the tax on this amount was less than $1
bil ion billion and much of this amount may be due not to the cap but to failing to qualify in other ways. and much of this amount may be due not to the cap but to failing to qualify in other ways.
For that same year, the reported revenue loss from untaxed capital gains was estimated at $5.8 For that same year, the reported revenue loss from untaxed capital gains was estimated at $5.8
bil ion.28 billion.²⁶ Thus, the presence of the cap limited the amount of revenue loss from the exclusion of Thus, the presence of the cap limited the amount of revenue loss from the exclusion of
capital gains by less than—perhaps much less than—17%.capital gains by less than—perhaps much less than—17%.
Moreover, the data Data collected on tax returns filed in 1995 and 1996 (before the 1997 change) collected on tax returns filed in 1995 and 1996 (before the 1997 change)
indicate that the benefits did not solely or even largely accrue to high income individuals if indicate that the benefits did not solely or even largely accrue to high income individuals if
income is measured without including the gain itself.income is measured without including the gain itself.2927 These data show large shifts in the These data show large shifts in the
distribution between 1995 and 1996, but in both years from 20% to 25% of the tax that would distribution between 1995 and 1996, but in both years from 20% to 25% of the tax that would
have been collected under the new law accrued to individuals with incomes below $20,000. In have been collected under the new law accrued to individuals with incomes below $20,000. In
1996, very little of the tax (less than 20%) would have been paid by those with incomes over 1996, very little of the tax (less than 20%) would have been paid by those with incomes over
$100,000. The distribution of the tax that one might $100,000. The distribution of the tax that one might normal ynormally think would accrue to high-income think would accrue to high-income
individuals individuals may reflect sales due to divorce, job loss, and may reflect sales due to divorce, job loss, and il health. Indeed, wealthyill health. Wealthy individuals individuals
may be more likely to have the resources to keep their houses through these types of changes.may be more likely to have the resources to keep their houses through these types of changes.
As these data suggest, compared with other capital gains provisions, the cap on residential capital As these data suggest, compared with other capital gains provisions, the cap on residential capital
gains has relativelygains has relatively smal small revenue effects and plays a relatively revenue effects and plays a relatively smal small role in the distribution of role in the distribution of
the tax burden. Therefore, although revenue and distributional issues may be of concern, other the tax burden. Therefore, although revenue and distributional issues may be of concern, other
changes could easily be made that would accomplish those same goals.

24 T ax Policy Center, “Individual Income T ax on Long-T erm Capital Gains and Qualified Dividends,” T able T 21-0204.
https://www.taxpolicycenter.org/model-estimates/distribution-individual-income-tax-long-term-capital-gains-and-
qualified-67. Data on the division between qualified dividends and capital gains from Internal Revenue Service,
Statistics of Incom e, Individual Income T axes, 2019, T able 1.4, https://www.irs.gov/statistics/soi-tax-stats-individual-
statistical-tables-by-size-of-adjusted-gross-income.
25 Computed from T ax Policy Center, Baseline Distribution of Income and Federal T axes, T 21 -0087,
https://www.taxpolicycenter.org/model-estimates/baseline-distribution-income-and-federal-taxes-july-2021/t21-0087-
baseline; Average Effective T ax Rates–All T ax Units, T 21-0133, https://www.taxpolicycenter.org/model-estimates/
baseline-share-federal-taxes-july-2021/t21-0133-average-effective-federal-tax-rates, and Share of Federal T axes – All
T ax Units, T able T 21-0115, https://www.taxpolicycenter.org/model-estimates/baseline-share-federal-taxes-july-2021/
t21-0115-share-federal-taxes-all-tax-units.
26 U.S. Department of T reasury, Internal Revenue Service, Statistics of Income, Short T erm and Long T erm Capital
Gains by Asset T ype, T ax Year 1999, https://www.irs.gov/statistics/soi-tax-stats-sales-of-capital-assets-reported-on-
individual-tax-returns.
27 Inconsistencies in how the exclusion was actually reported on returns results in some uncertainty about the actual
size of the gain, but it should fall between these two values.
28 U.S. Congress, Joint Committee on T axation, Estimates of Federal Tax Expenditures for Fiscal Years 1999-2003,
committee print, 105th Cong., 2nd sess., December 14, 1998, JCS-7-98, p.18.
29 See Gerald Auten and Andrew Reschovsky, The New Exclusion for Capital Gains on Principal Residences, National
T ax Association, Working Paper, October 1998. A previous version of this paper was published in the Proceedings of
the 90th Annual Conference on Taxation of the National Tax Association (Washington, DC: National T ax Association,
1998), pp. 223-230.
Congressional Research Service

14

---

The Exclusion of Capital Gains for Owner-Occupied Housing

changes could easily be made that would accomplish those same goals. Indexing the Dollar Cap
Rather than eliminatingRather than eliminating the cap, another approach would be to adjust the ceiling to reflect recent the cap, another approach would be to adjust the ceiling to reflect recent
price changes and index it for future price changes. A commitment to indexing, rather than price changes and index it for future price changes. A commitment to indexing, rather than
intermittently changing the cap as has occurred with prior exclusions, would provide individuals intermittently changing the cap as has occurred with prior exclusions, would provide individuals
more assurances that they might not need to keep records. This change would cost less revenue. more assurances that they might not need to keep records. This change would cost less revenue.
Using the 2007 data, for example, doubling the exemptions would have cost about 60% of the Using the 2007 data, for example, doubling the exemptions would have cost about 60% of the
cost of eliminating them entirely, while increasing them by 180% (to reflect the change in cost of eliminating them entirely, while increasing them by 180% (to reflect the change in
housing priceshousing prices,) would cost about 70%. This cost would rise over time. would cost about 70%. This cost would rise over time.3028
Which index would be appropriate depends on the objective of the cap. The change in housing Which index would be appropriate depends on the objective of the cap. The change in housing
prices has far outstripped the change in the prices has far outstripped the change in the overal overall price level by any measureprice level by any measure. If the objective of If the objective of
the cap is to maintain a fixed inclusion to exclusion ratio, a house price index would be the cap is to maintain a fixed inclusion to exclusion ratio, a house price index would be
appropriate. If the objective is to fix the cap in real terms, an index to a general price rise would appropriate. If the objective is to fix the cap in real terms, an index to a general price rise would
be appropriate.be appropriate.
The Single Versus Joint Exclusion
Another issue is whether the single exclusion should remain at a level that is half the joint Another issue is whether the single exclusion should remain at a level that is half the joint
exclusion. In making the cap half as large for singles (or twice as large for married couples), the exclusion. In making the cap half as large for singles (or twice as large for married couples), the
provision departed from historical practices for the over-provision departed from historical practices for the over-agedage-55 exclusion. The 1997 change -55 exclusion. The 1997 change
doubled the existing $125,000 exclusion for singles, although that exclusion had not kept pace doubled the existing $125,000 exclusion for singles, although that exclusion had not kept pace
with house price changes because it had not been changed since 1981. If the 1981 value had been with house price changes because it had not been changed since 1981. If the 1981 value had been
adjusted based on the average house price, it would be $680,000 in 2021.adjusted based on the average house price, it would be $680,000 in 2021.3129 Thus, single Thus, single
individuals individuals who might have been eligiblewho might have been eligible for the old age exclusion have lost ground compared for the old age exclusion have lost ground compared
with some historical periods, while married couples have lost less. For an equivalent revenue with some historical periods, while married couples have lost less. For an equivalent revenue
cost, this approach favors married individuals relative to single individuals, including widows and cost, this approach favors married individuals relative to single individuals, including widows and
widowers. (Both types of taxpayers could have been made worse off because there was no cap on widowers. (Both types of taxpayers could have been made worse off because there was no cap on
rollovers.)rollovers.)
Al owing Allowing the exclusion to be half as large for single taxpayers may have reflected, to some extent, the exclusion to be half as large for single taxpayers may have reflected, to some extent,
the tax planning problems faced by divorcing couples. If each taxpayer has the same ceiling, then the tax planning problems faced by divorcing couples. If each taxpayer has the same ceiling, then
it is more advantageous to it is more advantageous to sel sell a house with a large gain after the divorce, when each individual a house with a large gain after the divorce, when each individual
could have a full exclusion. This problem may have been less important for older individuals in could have a full exclusion. This problem may have been less important for older individuals in
the past when divorce was less likely, but with the exclusion substituting for rollover treatment, the past when divorce was less likely, but with the exclusion substituting for rollover treatment,
many more divorcing couples would be facing this problem. Higher-income individuals who many more divorcing couples would be facing this problem. Higher-income individuals who
divorced and optimized their timing may be worse off under the post-1997 changes because they divorced and optimized their timing may be worse off under the post-1997 changes because they
were not eligiblewere not eligible for an uncapped rollover or larger exclusion. However, the new rules are for an uncapped rollover or larger exclusion. However, the new rules are
beneficial for moderate income divorcing couples who wish to trade down. The change in relative beneficial for moderate income divorcing couples who wish to trade down. The change in relative
exclusions could have addressed the problem of unmarried couples who own houses together, an exclusions could have addressed the problem of unmarried couples who own houses together, an
issue that arose as part of the discussion of the issue that arose as part of the discussion of the “"marriage penaltymarriage penalty”" in the income tax rate in the income tax rate
structure. This latter phenomenon is probably not very structure. This latter phenomenon is probably not very numerical ynumerically important since, according to Census data, unmarried couples were only 7% of households.³⁰ important since, according to

30 T his estimate eliminated the tax on the $250,000 to $1 million classes of gains and increased the exemptions for the
$1 million and over classes.
31 Different values would be found if indexing where introduced from earlier levels. For example, using the Census
Bureau’s average new house index cited above, indexing from the 1964 level would have implied a current exclusion
that was slightly larger than the $250,000 one now allowed: $274,500. T he value had deteriorated by 1976, so that the
exclusion indexed from that point would be $200,000. Indexing from 1978, when a much larger exclusion was enacted
would produce a value of $439,000.
Congressional Research Service

15

---

The Exclusion of Capital Gains for Owner-Occupied Housing

Census data, unmarried couples were only 7% of households.32 Moreover, because they tend to be
Moreover, because they tend to be younger, they are less likelyyounger, they are less likely to be homeowners.to be homeowners.
Many of the single individuals Many of the single individuals sel ing selling homes, outside of divorcing couples, are likely to be homes, outside of divorcing couples, are likely to be
widows or widowers and the remainder are largely people who have never been married or who widows or widowers and the remainder are largely people who have never been married or who
have been divorced for some time. By reducing the exclusion ceiling for them, not only is the have been divorced for some time. By reducing the exclusion ceiling for them, not only is the
benefit reduced relative to historical values, but complexity is introduced because more benefit reduced relative to historical values, but complexity is introduced because more
individuals wil individuals will be subject to filing requirements and paying taxes. As noted above, be subject to filing requirements and paying taxes. As noted above, 7280% of % of
houses sold are estimated to have values over $250,000.houses sold are estimated to have values over $250,000.
Although it eliminatedAlthough it eliminated the complexity for divorcing couples, the halving of the exclusion the complexity for divorcing couples, the halving of the exclusion
especial yespecially magnified compliance problems for surviving spouses. Although surviving spouses can magnified compliance problems for surviving spouses. Although surviving spouses can
receive the benefit of the step-up in basis for the half of the house receive the benefit of the step-up in basis for the half of the house al ocatedallocated to the decedent, the to the decedent, the
lower ceiling not only increases the frequency with which basis must be calculated (any time the lower ceiling not only increases the frequency with which basis must be calculated (any time the
sales price is $250,000 or more) but also requires the measurement of the basis step-up.sales price is $250,000 or more) but also requires the measurement of the basis step-up. (Note:
Surviving spouses can get the full step up of the entire gain in community property states, such as
California.)31 These individuals may be more likely These individuals may be more likely to have houses that to have houses that fal fall into the taxable range into the taxable range
because they were married, perhaps for a long time. The lower limit in general adds to the risk because they were married, perhaps for a long time. The lower limit in general adds to the risk
that even a couple with a modest house that even a couple with a modest house wil will have to keep complex records because of the have to keep complex records because of the
possibility that one of them possibility that one of them wil will die before the house is sold.die before the house is sold.
One potential change would be to One potential change would be to al owallow surviving spouses to opt for the $500,000 exclusion as a surviving spouses to opt for the $500,000 exclusion as a
substitute for the step-up in basis if they are substitute for the step-up in basis if they are sel ingselling a house they lived in with their spouse, a a house they lived in with their spouse, a
move that would simplify compliance for those whose housing values move that would simplify compliance for those whose housing values fal fall between $250,000 and between $250,000 and
$500,000. H.R. 3803, introduced by Representative McCarthy in the $500,000. H.R. 3803, introduced by Representative McCarthy in the 109th109^th Congress, proposed Congress, proposed
this al owancethis allowance for certain surviving spouses. for certain surviving spouses.
In the In the 110th110^th Congress, a similar proposal was introduced by Senator Schumer (S. 138) and Congress, a similar proposal was introduced by Senator Schumer (S. 138) and
included in H.R. 3648, the Mortgage Forgiveness Debt Relief Act of 2007 (P.L. 110-142), which included in H.R. 3648, the Mortgage Forgiveness Debt Relief Act of 2007 (P.L. 110-142), which
was signed into law on December 20, 2007. was signed into law on December 20, 2007. Specifical ySpecifically, the new law , the new law al owsallows a surviving spouse a surviving spouse
to exclude from gross income up to $500,000 of the gain from the sale or exchange of a principal to exclude from gross income up to $500,000 of the gain from the sale or exchange of a principal
residence owned jointly with a deceased spouse residence owned jointly with a deceased spouse if the sale or exchange occurs within two years of the sale or exchange occurs within two years of
the death of the spouse the death of the spouse and other ownership and use requirements have been met. This provision other ownership and use requirements have been met. This provision
is limited to widows or widowers who is limited to widows or widowers who sel sell their houses quickly.their houses quickly.
Changing the Structure of the Exclusion
Another option is to change the structure of the exclusion in general. For example, there could be Another option is to change the structure of the exclusion in general. For example, there could be
a much larger lifetime exclusion, with each sale of a home using up part of the exclusion. A a much larger lifetime exclusion, with each sale of a home using up part of the exclusion. A
lifetime exclusion would eliminatelifetime exclusion would eliminate the incentive to turn over houses frequently and would the incentive to turn over houses frequently and would
eliminate eliminate the penalty for holding on to onethe penalty for holding on to one’'s home for a long period of time. It would shift s home for a long period of time. It would shift
benefits (even for the same revenue cost) from very wealthy people who benefits (even for the same revenue cost) from very wealthy people who sel sell houses frequently to houses frequently to
people who are less wealthy but have lived in their houses for a long time. It would, however, add people who are less wealthy but have lived in their houses for a long time. It would, however, add
to administrative costs and to complexity for some people who would need to keep track of the to administrative costs and to complexity for some people who would need to keep track of the
amount of the exclusion consumed.amount of the exclusion consumed.
A different approach would be that embodied in H.R. 2127 of the A different approach would be that embodied in H.R. 2127 of the 109th109^th Congress, which would Congress, which would
have al owedhave allowed a one-time doubling of the exclusion for those over the age of 50. a one-time doubling of the exclusion for those over the age of 50.

32 Benjamin Gurrentz, “ Cohabiting Partners Older, More Racially Diverse, More Educated, Higher Earners,”
September 23, 2019, https://www.census.gov/library/stories/2019/09/unmarried-partners-more-diverse-than-20-years-
ago.html.
Congressional Research Service

16

---

The Exclusion of Capital Gains for Owner-Occupied Housing

Tax Sheltering of Investment Gains
Tax Sheltering of Investment Gains A final issue is whether additional measures should be taken to prevent the use of the exclusion A final issue is whether additional measures should be taken to prevent the use of the exclusion
from sheltering gains earned from investment property. Little to no evidence exists as to the from sheltering gains earned from investment property. Little to no evidence exists as to the
seriousness of this issue. According to revenue estimates, the restriction on like-kind exchanges seriousness of this issue. According to revenue estimates, the restriction on like-kind exchanges
enacted in 2005 (requiring a five-year test) enacted in 2005 (requiring a five-year test) wil will have a negligiblehave a negligible revenue effect ($200 revenue effect ($200 mil ion
million over 10 years).over 10 years).3332 The revenue loss from the converting of investment property into a residence is The revenue loss from the converting of investment property into a residence is
likely likely larger.larger.
Note that these These tax sheltering problems are not unique to current law; they existed under prior law tax sheltering problems are not unique to current law; they existed under prior law
as wel .
as well. To deal with the investment and like-kind exchanges, the provision requiring longer residence To deal with the investment and like-kind exchanges, the provision requiring longer residence
periods for like-kind exchanges could be expanded to property used as an investment. Anotherperiods for like-kind exchanges could be expanded to property used as an investment. Another,
more direct approach, which might be used to raise revenue to finance cap expansions, would be more direct approach, which might be used to raise revenue to finance cap expansions, would be
requiring the gain attributable to investment property to be separated out and taxed, as recaptured requiring the gain attributable to investment property to be separated out and taxed, as recaptured
depreciation is now taxed.depreciation is now taxed.
The conversion of investment property is probably the most The conversion of investment property is probably the most importantsignificant tax avoidance scheme. tax avoidance scheme.
Techniques such as buying a house with extensive land, establishing a vacation home as a Techniques such as buying a house with extensive land, establishing a vacation home as a
residence, or explicit house swapping can probably only be addressed through tax auditing. These residence, or explicit house swapping can probably only be addressed through tax auditing. These
shelters would perhaps be made less attractive with longer holding periods, but longer holding shelters would perhaps be made less attractive with longer holding periods, but longer holding
periods have other consequences (such as interfering with mobility). The effect of longer holding periods have other consequences (such as interfering with mobility). The effect of longer holding
periods would not be as onerous, however, because houses held for a short period of time are periods would not be as onerous, however, because houses held for a short period of time are
likely likely to have littleto have little appreciation, appreciation, especial yespecially after deducting real estate commissions and other after deducting real estate commissions and other
sel ingselling costs. Partial exclusion could be costs. Partial exclusion could be al owedallowed for cases where sales were due to employment for cases where sales were due to employment
changes, and other factors. In addition, record keeping for a few years is not the burden that changes, and other factors. In addition, record keeping for a few years is not the burden that
would be the case if the house was owned for decades. House swapping would be reduced or would be the case if the house was owned for decades. House swapping would be reduced or
eliminated if the ceilings were increased or eliminated. It is very difficult to deal with the eliminated if the ceilings were increased or eliminated. It is very difficult to deal with the
professional professional “"fixer-upperfixer-upper”" problem, although, as in the case of other tax avoidance schemes, problem, although, as in the case of other tax avoidance schemes,
longer holding period requirements would discourage such methods.longer holding period requirements would discourage such methods.
Conclusion
Capital gains on sales of taxpayersCapital gains on sales of taxpayers’' homes have been homes have been preferential ypreferentially treated in the tax code for treated in the tax code for
decades. Current law decades. Current law al owsallows an exclusion from income taxation of up $500,000 in capital gains an exclusion from income taxation of up $500,000 in capital gains
for couples ($250,000 for singles). for couples ($250,000 for singles). This preferential treatment is justified for several reasons.
Several arguments are made in support of this preferential treatment. Capital gains taxes on homes create barriers to labor mobility in the economy. Imposing capital Capital gains taxes on homes create barriers to labor mobility in the economy. Imposing capital
gains taxes on homes also creates significant compliance costs, requiring individuals to keep gains taxes on homes also creates significant compliance costs, requiring individuals to keep
records for decades and to make fine distinctions between improvements and repairs. Capital records for decades and to make fine distinctions between improvements and repairs. Capital
gains taxes also tend to distort housing choices, discouraging individuals from gains taxes also tend to distort housing choices, discouraging individuals from sel ingselling their homes their homes
because of changing family and health circumstances. The taxation of gains in excess of a cap because of changing family and health circumstances. The taxation of gains in excess of a cap
creates inequities between homeowners with different job circumstances, those living in different creates inequities between homeowners with different job circumstances, those living in different
parts of the country, and those with different health outcomes. Exclusions of gains on homes do, parts of the country, and those with different health outcomes. Exclusions of gains on homes do,
however, contribute to tax avoidance schemes, however, contribute to tax avoidance schemes, especial yespecially ones that ones that al owallow gains on investment gains on investment
properties to escape tax.

33 U.S. Congress, Joint Committee on T axation, Estimated Budget Effects of the Conference Agreement for H.R 4520,
The “American Jobs Creation Act of 2004,” committee print, 108th Cong., 2nd sess., October 7, 2004, JCX-69-04.
Congressional Research Service

17

---

The Exclusion of Capital Gains for Owner-Occupied Housing

properties to escape tax. The exclusion from capital gains tax for owner-occupied housing currently exempts most The exclusion from capital gains tax for owner-occupied housing currently exempts most
homeowners from the tax. Although the capital gains exclusion adds to the magnitude of homeowners from the tax. Although the capital gains exclusion adds to the magnitude of
Congressional Research Service

18

---

The Exclusion of Capital Gains for Owner-Occupied Housing

homeowner preferences that may distort investment, there are reasons to exempt capital gains on homeowner preferences that may distort investment, there are reasons to exempt capital gains on
home sales from tax. The rise in housing prices juxtaposed with the fixed dollar cap for the home sales from tax. The rise in housing prices juxtaposed with the fixed dollar cap for the
exclusion, however, has increased the share of homeowners subject to gains tax. The possibility exclusion, however, has increased the share of homeowners subject to gains tax. The possibility
of capital gains tax in the future, arising from a cap that does not keep pace with housing prices, of capital gains tax in the future, arising from a cap that does not keep pace with housing prices,
substantial ysubstantially reduces the number of taxpayers who could be freed from detailed record keeping. reduces the number of taxpayers who could be freed from detailed record keeping.
The problems associated with the gains tax could be eliminated or mitigated with the elimination The problems associated with the gains tax could be eliminated or mitigated with the elimination
of the cap or by indexing it to housing prices. The ceiling on the excluded gain, presumably of the cap or by indexing it to housing prices. The ceiling on the excluded gain, presumably
adopted for revenue and distributional reasons, is, however, of adopted for revenue and distributional reasons, is, however, of smal small consequence compared with consequence compared with
other provisions (such as the general taxes and taxes on capital gains and dividends). A other provisions (such as the general taxes and taxes on capital gains and dividends). A
complication of increasing or eliminatingcomplication of increasing or eliminating the ceiling, however, is the increased opportunity for the ceiling, however, is the increased opportunity for
tax sheltering activities, which may suggest additional restrictions aimed at these activities.tax sheltering activities, which may suggest additional restrictions aimed at these activities.

Author Information

Jane G. Gravelle

Senior Specialist in Economic Policy



Disclaimer
This document was prepared by the Congressional Research Service (CRS). CRS serves as nonpartisan
shared staff to congressional committees and Members of Congress. It operates solely at the behest of and
under the direction of Congress. Information in a CRS Report should n ot be relied upon for purposes other
than public understanding of information that has been provided by CRS to Members of Congress in
connection with CRS’s institutional role. CRS Reports, as a work of the United States Government, are not
subject to copyright protection in the United States. Any CRS Report may be reproduced and distributed in
its entirety without permission from CRS. However, as a CRS Report may include copyrighted images or
material from a third party, you may need to obtain the permission of the copyright holder if you wish to
copy or otherwise use copyrighted material.

Congressional Research Service
RL32978 · VERSION 10 · UPDATED
19

Footnotes

1.

For average and median house prices, see FRED Economic Data, Average Prices of Houses Sold for the United States, https://fred.stlouisfed.org/series/ASPUS and Median Sales Price of Houses Sold for the United States, https://fred.stlouisfed.org/series/MSPUS.

2.

See Bureau of Economic Analysis, National Income and Product Accounts, Table 1.1.4, https://apps.bea.gov/iTable/iTable.cfm?reqid=19&step=2#reqid=19&step=2&isuri=1&1921=survey.

3.

Some exceptions to these rules exist. If taxpayers have not lived in the primary residence for a total of two years out of the last five, they are eligible for a partial exclusion cap if the real estate was sold because of a change in employment, health, or unforeseen circumstances. The taxpayer can receive a portion of the exclusion cap, based on the portion of the two-year period they resided in the home. For example, a single taxpayer who lived in the house for one year and qualified for an exception would have a $125,000 cap. For people living in a nursing home, the ownership and use test is lowered to one out of five years before entering the facility. And time spent in the nursing home still counts toward ownership time and use of the residence. For example, if a taxpayer lived in a house for a year, and then spent the next five years in a nursing home before selling the home, the full $250,000 exclusion would be available.

No rationale is stated in the legislative history of this long-standing provision, although proposals have been made to alter it. One possible explanation is that it may help address the difficulty with establishing basis for assets held for a long time.

4.

U.S. Congress, Senate Committee on Finance, The Revenue Act of 1951: Report to Accompany H.R. 4473, 82^nd Cong., 1^st sess., S.Prt. 82-781 (GPO, 1951), p. 34.

5.

U.S. Congress, House Ways and Means Committee, Report to Accompany H.R. 8363, 88^th Cong., 1^st sess., H. Prt. 88-749 (GPO, 1963).

6. Joint Committee on Taxation, Estimates Of Federal Tax Expenditures For Fiscal Years 2024-2028, JCX-48-24, December 11, 2024, https://www.jct.gov/publications/2024/jcx-48-24/. 7. Joint Committee on Taxation, Estimates Of Federal Tax Expenditures For Fiscal Years 1998-2002, JCS-22-97, December 15, 1997, https://www.jct.gov/publications/1997/jcs-22-97/ and Estimates Of Federal Tax Expenditures For Fiscal Years 2000-2004, JCS-13-99, December 22, 1999, https://www.jct.gov/publications/1999/jcs-13-99/. 8.

See Gerald Auten and Jane G. Gravelle, "The Exclusion of Capital Gains on the Sale of Principal Residences: Policy Options," National Tax Association Proceedings, 102 Annual Conference on Taxation, 2009, https://ntanet.org/wp-content/uploads/proceedings/2009/012-auten-the-exclusion-capital-2009-nta-proceedings.pdf. Because of the way taxpayers reported their transactions, it was not possible to determine precisely which taxpayers reached the maximum exclusion.

9.

The Auten and Gravelle study indicated that 2,000 taxpayers were subject to the limit in 1999. In that year, home sales were 5.21 million. See TitleNews Online Archive, "2001 A New Record, December Existing-Home Sales Strong?" NAR Reports, January 28, 2002, https://www.alta.org/news/news.cfm?20020128-2001-A-New-Record-December-Existing-Home-Sales-Strong—NAR-Reports.

10.

National Association of Realtors, "Existing Home Sales," Supplemental Data, May 2025, https://www.nar.realtor/sites/default/files/2025-06/ehs-05-2025-supplemental-data-2025-06-23.pdf.

11.

There are later data on sales of residences reported in IRS statistics through 2015 at https://www.irs.gov/statistics/soi-tax-stats-sales-of-capital-assets-reported-on-individual-tax-returns. However, these data are greatly affected by the financial crisis and the decline in the number and price of home sales. Between 2007 and 2010 gains on residences subject to tax fell by 70%, and by the last year data are available gains were still 30% below their 2007 level. This disruption makes it difficult to rely on data during that period.

12.

This ratio would be somewhat high because some of the excluded gain currently would have been taxed at 20% and some of the included taxed at 15%. However, some of the excluded gain would be taxed at a zero rate while very little if any of the included gain would be, which would increase the ratio.

13.

CRS calculations based on CRS Report R48277, CRS Model Estimates of Marginal Effective Tax Rates on Investment Under Current Law, by Mark P. Keightley and Jane G. Gravelle. 2017 and 2027 tax rates are from CRS Report R48153, Marginal Effective Tax Rates on Investment and the Expiring 2017 Tax Cuts, by Jane G. Gravelle and Mark P. Keightley.

14.

See CRS In Focus IF11305, Why Subsidize Homeownership? A Review of the Rationales, by Mark P. Keightley for a discussion.

15.

Leonard E. Burman, Sally Wallace, and David Weiner, "How Capital Gains Taxes Distort Homeowners' Decisions," Proceedings of the 89^th Annual Conference on Taxation of the National Tax Association (National Tax Association, 1997), pp. 382-390.

16.

If a surviving spouse and the decedent owned the home jointly, the basis in the home changes after the death of the decedent. The new basis for the half interest that the decedent owned will be one-half of the fair market value on the date of death (or alternate valuation date). For example, suppose a couple jointly owned a home that had an adjusted basis of $100,000 on the date of one spouse's death. The fair market value on that date was $200,000. The new basis in the home is $150,000 ($50,000 for one-half of the adjusted basis plus $100,000 for one-half of the fair market value).

17.

Calculating capital gains requires a measure of basis. A taxpayer's basis in real estate is cost (or fair market value if acquired by inheritance). The cost of property is the amount paid for it in cash, debt obligations, other property, or services, which can include the purchase price and certain settlement or closing costs. When calculating the gain or loss on the sale of a residence, the basis is adjusted for changes made since the acquisition of the property. Increases to basis include the cost of capital improvements, such as air conditioning or a new roof; special assessments for local improvements; and any other additions that have a useful life of more than one year. Examples of decreases to basis include any capital gain that was postponed from the sale of a previous home before May 7, 1997; deductible casualty losses or insurance payments received for casualty losses; payments received for granting an easement or right-of-way; depreciation allowed if the home was used for business or rental purposes; a first-time homebuyer credit (allowed to certain first-time buyers of a home in the District of Columbia); and energy conservation subsidy excluded from gross income because it was received to buy or install any energy conservation measure.

18.

U.S. Congress, Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997, 105^th Cong., 1^st sess. (GPO, 1997), pp. 54-55.

19.

U.S. Congress, Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997, 105^th Cong., 1^st sess. (GPO, 1997), pp. 54-55.

20.

The recapture rule, enacted by the Taxpayer Relief Act of 1997, applies to depreciation claimed after May 6, 1997. Any depreciation taken before that date is "forgiven" and not recaptured.

21.

More information available in CRS Report RS22113, The Sale of a Principal Residence Acquired Through a Like-Kind Exchange, by Gregg A. Esenwein (out of print but available to congressional staff from the author).

22.

Congressional Budget Office, "Revenue Projections," January 2025, https://www.cbo.gov/data/budget-economic-data#3. The Tax Policy Center estimates that 93% of the tax on capital gains and dividends is paid by those with income over $200,000 and that 72% is paid by those with income over $500,000. See "Table 23-0017—Distribution of Individual Income Tax on Long-Term Capital Gains and Qualified Dividends by Expanded Cash Income Level, 2025," https://taxpolicycenter.org/model-estimates/distribution-individual-income-tax-long-term-capital-gains-and-qualified-93, Capital gains alone would be even more concentrated in higher incomes.

23. Computed from Congressional Budget Office, "Revenue Projections," January 2025, https://www.cbo.gov/data/budget-economic-data#3. The Tax Policy Center estimates that 80% of income taxes are paid by those with income over $200,000. Tax Policy Center, "Table T22-0097—Share of Federal Taxes—All Tax Units, By Expanded Cash Income Level," 2025, https://taxpolicycenter.org/model-estimates/baseline-share-federal-taxes-october-2022/t22-0097-share-federal-taxes-all-tax-units. 50% of income taxes are estimated to be paid by those with incomes over $500,000, or about $1.3 trillion. 24.

U.S. Department of the Treasury, Internal Revenue Service, Statistics of Income, Short Term and Long Term Capital Gains by Asset Type, Tax Year 1999, https://www.irs.gov/statistics/soi-tax-stats-sales-of-capital-assets-reported-on-individual-tax-returns.

25.

Inconsistencies in how the exclusion was actually reported on returns results in some uncertainty about the actual size of the gain, but it should fall between these two values.

26.

U.S. Congress, Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 1999-2003, committee print, 105^th Cong., 2^nd sess., December 14, 1998, JCS-7-98, p.18.

27.

See Gerald Auten and Andrew Reschovsky, The New Exclusion for Capital Gains on Principal Residences, National Tax Association, Working Paper, October 1998. A previous version of this paper was published in the Proceedings of the 90^th Annual Conference on Taxation of the National Tax Association (National Tax Association, 1998), pp. 223-230.

28.

This estimate eliminated the tax on the $250,000 to $1 million classes of gains and increased the exemptions for the $1 million and over classes.

29.

Different values would be found if indexing where introduced from earlier levels. For example, using the Census Bureau's average new house index cited above, indexing from the 1964 level would have implied a current exclusion that was slightly larger than the $250,000 one now allowed: $274,500. The value had deteriorated by 1976, so that the exclusion indexed from that point would be $200,000. Indexing from 1978, when a much larger exclusion was enacted would produce a value of $439,000.

30.

Benjamin Gurrentz, "Cohabiting Partners Older, More Racially Diverse, More Educated, Higher Earners," September 23, 2019, https://www.census.gov/library/stories/2019/09/unmarried-partners-more-diverse-than-20-years-ago.html.

31.

Surviving spouses can get the full step-up of the entire gain in community property states, such as California.

32.

U.S. Congress, Joint Committee on Taxation, Estimated Budget Effects of the Conference Agreement for H.R 4520, The "American Jobs Creation Act of 2004," committee print, 108^th Cong., 2^nd sess., October 7, 2004, JCX-69-04.

---