The Policy Loophole Putting The Brakes On America’s Housing Supply

America’s housing crisis has a tax problem hiding in plain sight.

Home prices have risen 53% since 2019 while median household income has risen only 24%. Affordable inventory remains constrained, leaving home sales depressed.

Higher mortgage rates have made affordable homes harder to find. According to Realtor.com data, the number of homes listed for sale that are affordable to households earning $75,000 or less has fallen 60% since 2019.

However, Congress has the opportunity to address another supply issue: the longstanding cap on capital-gains exclusion for the sale of primary residences, which has remained unchanged in nominal terms since 1997.

This exclusion mainly impacts long-term homeowners in areas with high property appreciation, especially older homeowners considering downsizing. When selling a home creates an unexpected federal tax liability, these homeowners are often dissuaded from selling, reducing market supply.

Updating this exclusion isn’t a direct solution to affordability. Instead, it improves supply and mobility by removing a tax barrier, enabling homeowners to access existing homes without waiting years for new construction.

Congress enacted the exclusion in 1997; the median home price was approximately $145,000. Homeowners could exclude $250,000 of gain from taxation, or $500,000 for married couples. The thresholds have never been adjusted. Not once.

More than two decades ago, as Deputy Assistant Secretary of the Treasury for Economic Policy, I looked into updating these exclusions. Inflation had only modestly eroded their value then, and the Bush Treasury had other fiscal priorities. I should have pushed harder then. I’m pushing now.

According to the Federal Reserve Bank of Minneapolis, $500,000 in 1997 is equivalent to roughly $1 million today. The exclusion’s real value has effectively been cut in half.

Consider a married couple who bought a home for $300,000 in 1997 and sell it for $1.2 million in 2026, assuming no additional basis from improvements or selling expenses. After the $500,000 exclusion, $400,000 of gain would remain taxable. At a 20% capital-gains rate, plus the 3.8% net investment income tax if applicable, the federal bill could exceed $95,000.

Under an inflation-indexed exclusion of roughly $1 million, that couple would owe no federal capital-gains tax on the sale. They could move, putting their $1.2 million home on the market.

The evidence suggests tax policy affects these decisions. Between 2000 and 2003, only about 38,000 home sales annually involved gains exceeding the exclusion. By 2022, that figure had risen to more than 300,000 — nearly eight times as many. That does not mean every affected homeowner is delaying a sale. But it means the tax code now influences far more decisions.

Research by Federal Reserve economist Hui Shan found that the 1997 tax changes increased sales among homes with low and moderate gains and produced evidence of lock-in among homes with very large gains.

The lock-in problem is especially significant for older homeowners with considerable housing wealth. When inheriting, the stepped-up basis at death aligns the home’s basis with its market value at that time, often removing tax on appreciation accumulated over the years. This situation makes holding onto the property more financially attractive than selling.

Critics correctly point out that updating the exclusion mainly benefits wealthier homeowners in high-value appreciation states. But that is also the point. The homeowners most at risk of facing a tax penalty are often those able to sell their existing homes. The objective isn’t to enrich wealthy homeowners but to eliminate a tax penalty that deters them from selling homes that could be purchased by younger families.

In California, roughly one in four home sellers realizes more than $500,000 in gains; the share is also high in Hawaii, Washington, Massachusetts, and New York. These are precisely the markets where additional housing is most desperately needed.

Critics can also point to the cost. But the relevant question is not simply who receives the tax benefit; it is what the policy does to the housing market. More transactions would generate economic activity and additional tax revenue from gains above the new thresholds, as well as from the broader economic activity associated with buying and selling homes.

Congress has already recognized the problem. The More Homes on the Market Act would double the exclusion to $500,000 for single filers and $1 million for married couples, then index both amounts for inflation. Its bipartisan support — with 155 sponsors in the House and 23 in the Senate — reflects a simple reality: Congress can address this market problem.

Modernizing the exclusion would restore the law’s original purpose, remove an artificial brake on housing turnover, and put more homes back into circulation.

Congress should act before another generation of homeowners discovers that a tax provision written for the 1997 housing market no longer fits today’s.

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 James Carter is Principal & Policy Director at Navigators Global. He previously served in the Treasury Department, the White House, and as Chief Economist of the U.S. Senate Budget Committee.