How to Alleviate the Middle-Class Crunch on Homeownership

Working-age Americans increasingly fear that they will never be able to buy a home or move up from the home they already own. A 2022 Cato Institute poll found that 87 percent of Americans worry about housing costs, and 69 percent fear that their children or grandchildren will never be able to afford a home. These concerns reflect real pressures: Home prices remain high, mortgage rates have increased, and the supply of affordable homes is historically tight.

Federal tax policy is making the problem worse. Under current law, homeowners may exclude only $250,000 in capital gains if single, or $500,000 if married, when selling a primary residence. These limits were set during the Clinton administration in 1997 and have never been adjusted for inflation or for rising home values. After nearly three decades of appreciation, many ordinary homeowners already exceed these thresholds, and millions more are on the horizon. A tax rule that once protected most sellers now exposes millions of them to a substantial bill, all from gains derived by inflation (itself caused by the Federal Reserve and a big-spending Congress).

This misguided policy creates a strong lock-in effect that is undercutting housing supply. Families who might want to move for an extra bedroom, a shorter commute, a job change, or to downsize after the kids move out often stay put if their anticipated gain from selling the house exceeds the exclusion. Even homeowners whose houses no longer fit their needs choose not to sell because the tax consequences are too large. This reduces turnover and limits the number of homes available to younger families seeking entry into the market.

H.R. 1340, the More Homes on the Market Act, addresses this problem directly. The bill would double the capital gains exclusion to $500,000 for single filers and $1 million for married couples and would index those amounts to inflation. Modernizing the exclusion would allow homeowners to sell or change their housing without being penalized for decades of normal appreciation.

The bill is also modest in fiscal terms. The Joint Committee on Taxation has told congressional staff that H.R. 1340 would reduce federal revenues by a little more than $40 billion over a decade. That may sound large, but it is insignificant next to the roughly $63 trillion in federal tax revenue the Congressional Budget Office projects for 2025 through 2034. In exchange for a small reduction in revenue, Congress can meaningfully increase housing supply and mobility.

Moreover, revenue effects on the federal government are likely to be smaller than estimated. Older Americans already have a powerful tax incentive not to sell appreciated homes during their lifetimes. Under the step-up-in-basis rule, heirs inherit property at its current market value and can sell with little or no capital gains tax. Financial planners routinely advise Baby Boomers not to sell highly appreciated homes while they're alive and not to gift them to children before death, because doing so creates avoidable tax liability. Since many older homeowners already plan to hold their homes until death, raising the exclusion for living sellers would not significantly reduce revenue. Much of this appreciation was never going to be taxed on either side of the grave.

America’s affordable housing problem is not limited to expensive coastal markets such as Manhattan or San Francisco. The crisis now affects the entire country. Red and purple states have experienced rapid price increases as families move in search of more opportunity and lower costs. States such as Tennessee, Idaho, Utah, Florida, the Carolinas, and Texas have seen strong appreciation that can easily push ordinary homeowners past the outdated federal exclusion. A family in suburban Knoxville or Oklahoma City may now exceed the limit as readily as a family in Los Angeles. As more owners become locked in place, inventory in these regions continues to shrink.

Opponents sometimes argue that increasing the exclusion primarily benefits the wealthy. But the data do not support this view. According to the National Association of Realtors, 34 percent of homeowners risk exceeding the current $250,000 limit, and 10 percent of married homeowners risk exceeding the $500,000 limit. These are middle-class families who bought typical homes many years ago and simply benefited from long-term appreciation. Taxing them when they try to move distorts the market and contributes to the supply shortage.

Without reform, these pressures will intensify. Locked-in owners will continue to remain in place, limiting turnover and constraining supply. First-time buyers will face fewer listings and higher prices. Families seeking more space will struggle to move up. Reduced mobility will weaken labor markets and undermine community stability. All of these consequences flow from a provision of the tax code that no longer matches modern housing conditions.

H.R. 1340 avoids the pitfalls of heavy-handed interventions. It does not subsidize demand, impose new regulations, or require new spending. It simply removes a federal barrier that prevents homeowners from responding to normal life changes. Families will still sell only when it makes fiscal sense. This reform would merely eliminate an outdated and unintended income tax penalty that blocks ordinary residential mobility. Both YIMBYs and NIMBYs can support this tax cut.

Congress should pass H.R. 1340. Younger Americans deserve a functioning housing market. Older Americans deserve the freedom to move without facing a punitive tax bill. Updating the capital gains exclusion is a modest and targeted reform that would expand supply, strengthen families, and open doors for the next generation of homebuyers. The lack of housing supply — and the heightened costs associated with that shortfall — are creating enormous social and economic problems for people starting a family and attempting to build equity for retirement. This bill is a simple step that would go a long way toward alleviating this middle-class crunch.