The current housing market presents a challenging scenario with a significant shortage of available homes for prospective buyers. This scarcity of housing options, coupled with soaring mortgage rates, is making it increasingly difficult for individuals to find their dream homes. However, what if there were a way to incentivize people to sell their homes and increase housing inventory? In this article, we explore various approaches, including potential changes to the tax code, to address this pressing issue.
The Root of the Problem
One of the key reasons behind the limited housing inventory is the reluctance of existing homeowners to sell their properties. Many of these homeowners are locked into historically low mortgage rates, making it financially unviable for them to sell and purchase a new home with higher rates. Even if homeowners are dissatisfied with their current residences due to size or age constraints, they often find themselves trapped by their attractive interest rates. As explained by Sherry Chen, a Realtor at Kappel Realty Group in San Diego, “The primary reason why inventory is low is because about 80% of homeowners have an interest rate that’s lower than 5%. Even if a homeowner thinks their house is too small, too old, etc., they cannot afford to sell and purchase a bigger/better property at a rate that may be double than what their current rate is.”
To address this issue effectively, the government could leverage tax incentives to encourage homeowners to put their houses on the market, even when mortgage rates are high.
Option 1: Double the Capital Gains Exclusion
When homeowners sell their properties for more than their initial purchase price, they incur a capital gain that is subject to taxation. Currently, the capital gains exclusion allows for a tax-free gain of up to $250,000 for single filers and $500,000 for joint filers. A bill named the “More Homes on the Market Act” (H.R. 1321) introduced in the House aims to double these exclusion amounts. While this bill has yet to go through a hearing, it could potentially be a game-changer for homeowners who are hesitant to sell due to the fear of substantial tax liabilities.
The concept behind this proposal is to empower older homeowners, many of whom are residing in spacious houses, to downsize and sell their homes without the burden of capital gains tax. Presently, under the existing tax laws, older homeowners often retain their properties until their passing, allowing their heirs to inherit the property with more favorable tax treatment. This dynamic has led to an increasing share of homeowners being aged 55 and older, limiting the supply of housing for younger generations.
A study conducted by Andrew Hanson, an associate professor of real estate at the University of Illinois Chicago, and Ike Brannon, president of Capital Policy Analytics, suggests that increasing the capital gains exemption could potentially result in 159,000 to 344,000 additional homes being listed for sale in the first year.
Option 2: $25,000 Credit for Long-Term Homeowners
Another intriguing proposition is to provide a $25,000 tax credit to homeowners who sell their primary residences after living in them for at least 20 years. This initiative aims to stimulate 296,000 to 640,000 homeowners to put their homes on the market. The proposed tax credit is notably more generous than the incentives offered to home buyers from 2008 to 2010, which were moderately successful in boosting home sales.
Option 3: Reduce Capital Gains Tax for Small Landlords
Another proposal discussed by Hanson and Brannon is a temporary 50% reduction in the capital gains tax rate for small landlords who sell single-family rental properties to first-time homebuyers. This measure has the potential to increase the supply of homes for sale by an estimated 67,000 to 146,000 units.
This proposal is particularly important as small-time landlords, defined as those who own five or fewer properties, collectively own half of the single-family rental properties across the nation. Offering them a tax incentive may encourage them to sell, thereby expanding the inventory of available homes.
Implementing Limited-Time Incentives
To maximize the effectiveness of these proposals, Hanson and Brannon recommend implementing a “short time window” for the 20-year tax credit and the capital gains tax reduction for small landlords. Setting a time limit would prompt property owners to act swiftly, potentially alleviating the current housing shortage. This approach has previously proved successful in spurring action, as seen with the surge in home sales just before the expiration of certain tax credits in 2009 and 2010.
Regarding the proposal to double the capital gains exclusion on primary home sales, the authors advise against adjusting it for inflation. This approach would incentivize homeowners to expedite their home sales, thereby increasing the supply of available homes.
A Comprehensive Approach
While the proposed tax-related solutions offer short-term fixes to increase housing inventory, it is essential to recognize that they alone will not resolve the overall housing crisis. According to Lisa Sturtevant, chief economist for Bright MLS, addressing the broader issue of housing supply is crucial. She emphasizes that making it easier to construct new housing is the most significant step toward resolving the housing crisis. However, this responsibility often falls on cities and counties, as they hold the power to make land-use decisions, rather than the federal government. Thus, the effort to increase housing supply must begin at the grassroots level to effectively combat the housing shortage.
In conclusion, addressing the housing market’s challenges requires innovative solutions that extend beyond traditional approaches. By introducing tax incentives, the government can play a vital role in motivating homeowners to sell their properties, thereby expanding housing inventory. Additionally, local governments must facilitate the construction of new housing to address the broader issue of housing supply. Through a combination of short-term tax initiatives and long-term structural changes, we can strive to create a healthier and more balanced housing market for the benefit of all.