Hidden Home Equity Tax Hits Longtime Owners

AUSTIN, Texas — Millions of American homeowners are sitting on a hidden tax burden they never planned for – one that threatens their hard-earned home equity and, at the same time, is tightening the nation's already strained housing supply.

Today, roughly 1 in 3 homeowners – nearly 29 million households – have built up more home equity than the federal capital gains tax exclusion for single filers protects when they sell their primary home, according to a recent analysis by the National Association of Realtors®. By 2030, that number is expected to grow to 56% of homeowners.

Most people don’t think of their home as a taxable investment. It’s their nest egg, future college fund or inheritance for their kids. But an outdated federal rule, left unchanged since 1997, means the longer you stay and the more your home appreciates, the more likely the IRS will claim a cut when you finally sell.

This home equity tax has big consequences. It erodes family wealth right when people need it most. It discourages older owners from downsizing or moving closer to care. And it keeps larger, family-sized homes off the market, fueling the inventory crunch that’s driving up prices for everyone.

Why the home equity tax exists

The roots of this growing problem stretch to 1997, when Congress rewrote the rules for taxing homeowners’ profits from selling a primary residence. Before then, the process was complicated and frustrating: Sellers could defer paying capital gains taxes if they bought a more expensive home, but they had to keep decades of receipts and faced a tax hit if they ever wanted to downsize.

“It was a compliance mess,” says Evan Liddiard, the NAR's director of tax policy. “You had to keep track of the first home that you bought and every improvement in every home over the course of a lifetime to show how much gain you ultimately had.”

The 1997 change fixed that headache. It gave homeowners the freedom to exclude up to $250,000 in profit if single, or $500,000 if married and filing jointly, every time they sold a primary home with few strings attached.

The simplicity was key: For most people, the exclusion was so generous that meticulous record-keeping was no longer necessary – and it opened the door to using their home equity to help fund retirement, pay for medical care, or support their kids’ education.

But there was one major oversight: Congress never linked those exclusions to inflation, and now, homeowners are paying the price.

In the decades since, home prices have climbed more than 260%, while the tax exemption has stayed exactly the same. If it had kept pace, the cap would now be about $660,000 for individuals and $1.32 million for couples, according to research from the University of Illinois Chicago.

Who’s most exposed

The financial shock isn’t spread evenly. While nearly 1 in 3 homeowners nationwide is already at risk of a surprise capital gains bill, those hit hardest are the owners who’ve stayed put the longest – especially in states where home values have soared the fastest.

Hawaii tops the list. About 79% of homeowners there could be affected by the $250,000 exclusion limit, with an average capital gain over the exclusion of more than $409,000 per household. Washington follows closely, with nearly 65% of owners at risk. By comparison, West Virginia and Mississippi see the least impact, with less than 8% of homeowners potentially exposed.

And the dollar impact is just as lopsided. Nationwide, the average potential federal tax bill for over-the-limit homeowners is about $35,000. But in Hawaii, the average homeowner who surpasses the single-filer cap has an additional $409,346 in gain at risk of taxation.

When considering the higher joint-filer exclusion, exposure remains significant: Nearly half of Hawaii’s homeowners and about 31% in California could get hit. In Wyoming, the average homeowner over the joint limit could see nearly a half-million dollars exposed to taxation – the highest in the nation.

These figures highlight a hard truth: Homeowners in the most competitive markets – the same places where first-time buyers already struggle – are sitting on equity they can’t unlock without paying a steep price, keeping homes off the market where supply is needed most.

The capital gains cliff: Real money, real pain

For middle-class Americans, the real pain isn’t just the dollar figure, but the ripple effect on how families plan, retire, and pass down wealth.

Most homeowners built equity the old-fashioned way, by staying in place and paying down a mortgage over decades. But those who’ve followed this tried-and-true advice have now grown their equity so high that cashing in on it can seem more like a penalty than a reward.

“This really is a tax on home equity,” says Shannon McGahn, executive vice president and chief advocacy officer of the NAR. “And without that tax being indexed for inflation, it’s increasingly hitting the middle class and older homeowners harder than most.”

Instead of tapping that equity to age comfortably or assist the next generation, many owners now feel forced to keep it locked up until they pass away, because if they hold on to the house, heirs receive a stepped-up basis and avoid the capital gains bill altogether.

“Many people don't consider their home as a capital asset that they have to pay tax on,” adds Liddiard. “And now, we're suddenly getting to the point where a whole generation is finding out from their accountant that if they sell their house, they’re going to have to pay $80,000 or $200,000 or whatever it might be in capital gains tax. And they're saying, ‘What? I had no idea!’”

For middle-income families, this creates a lose-lose situation: Either sell now and hand over a huge slice of your hard-earned profit or hold the asset just to avoid a tax that many assumed they’d never owe in the first place. In the meantime, younger buyers lose out on homes that could otherwise hit the market, feeding an affordability crunch for everyone.

Penalized if you stay, penalized if you sell

For longtime homeowners sitting on decades of appreciation, the prospect of selling and triggering a five- or six-figure tax bill often seems untenable. Some, as Liddiard explains, simply give up on using their whole house.

"We hear reports from some of our members saying some of these folks have moved to the main floor of their home, and they never go upstairs, never go downstairs, because they're too feeble to do so,” he says. “But they either can't afford to pay the capital gains tax, or they refuse to, because they know that when they die, the home can get a step up in basis [and] nobody has to pay the taxes."

“I’ve been working with a neighbor for more than a decade who refuses to sell his property – even though it could easily go for $600,000 – because he doesn’t want to take the hit from Uncle Sam,” says Michelle Doherty, a Realtor® with RLAH Real Estate in Arlington, VA. “He’s a World War II veteran and the nicest guy in the world, but he always tells me, ‘I’ve given Uncle Sam enough.’ It’s a perfect example of how these outdated capital gains thresholds are keeping homes off the market.”

But staying put doesn’t always mean financial safety. In many areas, local property taxes have surged alongside home values, leaving older homeowners paying annual bills that now exceed what their mortgage once was. For people on fixed incomes, that adds another layer of pressure.

Some high-cost states offer protections like assessment caps to help longtime residents stay in their homes. But those protections often vanish upon sale. That means moving – even to a smaller home – resets the property tax rate and can wipe out any financial breathing room.

“Folks in California have been living with this problem probably longer than most other areas of the country,” says Liddiard. “They’ve got limits on how much the property [tax] can go up, but if they sell the house, that starts all over again.”

The result is a painful double bind. Middle-class homeowners who played by the rules – stayed in one place, paid off their mortgage, built equity – now find themselves stuck. And as more of those homes stay off the market, younger buyers feel the strain, too.

What’s next?

Without action, this hidden tax is only set to grow. By 2035, projections show that 13 states could see at least 90% of homeowners exposed to federal capital gains taxation – including those that were once synonymous with low-cost, low-tax living like Florida, Nevada, and Arizona.

Industry advocates say the solution is straightforward. Update the exclusion limits to reflect how much home prices have climbed since 1997, and make sure those limits automatically adjust for inflation going forward. A bipartisan proposal in Congress, the More Homes on the Market Act, would roughly double the current exemption to $500,000 for individuals and $1 million for couples, restoring the law’s original intent to protect everyday homeowners, not penalize them.

In the meantime, advocates are focused on educating homeowners about their tax risk.

“The more people know that this is coming, the more their voices can be heard,” says McGahn.

Source: Realtor.com

© 2025 Florida Realtors®