How to free up inventory in the real estate market
Here’s a scenario that happened to my friend’s parents:
They bought a house in San Diego in the 1970s before they had kids. They paid around $20,000 for the house.
In the 1980s, after having kids, they moved to a bigger house in a different part of the county where the schools were better. The housing market was unusual in the ’80s, so they kept the $20,000 house and converted it into a rental property. It’s now 2024, and they are retired.
The $20,000 house is now worth $1.2 million. They want to sell the house and use the profits help fund their retirement. However, after speaking with their accountant, they learned that if they sold the house, they would owe around $700,000 in taxes, including both state and federal taxes. They are currently receiving about $3,500 in rent from the house, so they decided not to sell it and to keep it as a rental.
This story is more common than people think. Many boomers are sitting on significant real estate holdings but don’t want to sell due to the tax burden.
My Proposal
We should create a one-time tax holiday to allow these individuals to sell their properties without paying capital gains taxes. The tax holiday would work as follows:
- If a second home or rental property has been owned for more than 10 years, the federal government would exempt capital gains taxes on the sale of the property and also not require the taxpayer to repay depreciation on the rental property.
- The seller should receive some form of tax credit for any state taxes paid.
- We could cap the tax holiday, for example, if the house is worth more than $1 million, we’d only exempt up to $1 million in capital gains.
- Implement a 3-4 year window to encourage people to sell sooner rather than waiting for further price appreciation.
Effects
Given the amount of equity tied up in real estate, this policy could unlock a significant amount of housing inventory. In California, about 20% of the population is over 60, and approximately 40% of single-family homes, condos, and townhomes in California are rentals. If we assume rentals are disproportionately owned by older people, this policy might not dramatically affect prices, but it would increase inventory, giving homebuyers more options.
Objections
One objection is that this policy would primarily benefit the wealthy. This is true. However, the current system isn’t exactly penalizing them. Rental property owners already receive numerous deductions and benefits under the current tax code. Another significant objection that deserves serious consideration is the concern that lawmakers might be reluctant to end the tax holiday, leading to it being extended indefinitely. If this happens, it could evolve into yet another regressive entitlement.