Home Ownership Costs: Capital Gains Taxes

Real estate ownership has implications for both income taxes during the ownership period and capital gains on the sale.

Repost from OC Housing News 2011-2016

taxmanSome people buy houses because they are “tired of paying so much in taxes.” Homeownership provides the taxpayer the ability to write off the cost of interest on a home mortgage, and they can deduct property taxes as well.

Unfortunately, while these tax deductions may lower the bill to Uncle Sam, they come with a cost, and often in Coastal California, the cost outweighs the benefit. Many people end up paying more in interest than they save in taxes. So while it may relieve a high wage earner to avoid paying Uncle Sam, giving far more money to a banker makes little sense.


Owning real estate has two significant tax benefits: (1) favorable capital gains tax exemptions and (2) income tax benefit through the home mortgage interest deduction (HMID). Be forewarned that this is not an exhaustive treatise on every permutation in the tax code. I am going to look at the general case the most people will find themselves in.

Capital Gains Taxes

rainbowIf you own a home more than two years, you can ignore the gains on the first $250,000 or $500,000 if your married. If you don’t make more than $250,000 or $500,000 on the sale — which most people don’t — then you don’t pay any capital gains taxes. It is a tremendous tax advantage that favors capital gains and appreciation.

The reason we have a large deduction or excluded amount is because years ago when there was no exclusion, long-term homeowners would be punished with capital gains taxes when they sold a principal residence when most of that gain was due to inflation. Without a method of adjusting the purchase price basis for inflation (like using the CPI), owners are being taxed on the profits created by inflation. They are getting less than their money back when you consider the loss in money’s purchasing power.

Personally, I think it would be a good idea to link the property basis to inflation. An exclusion can be created by linking the basis for the capital gains to the Consumer Price Index, and the tax can be levied on any overage. For instance. If someone purchased a home for $100,000 when the CPI was at 100, then later the property was sold for $300,000 when the CPI was at 200, the tax would be levied on only half the profit:

Adjusted Basis = Original Price times new CPI divided by old CPIobvious_choice

Adjusted Basis = $100,000 * 200 / 100 = $200,000.

$300,000 Resale Price

$200,000 Adjusted Basis

$100,000 Profit subject to Capital gains tax.

This gets around the issue of inflation taxing while taxing irrational exuberance. Unfortunately, it will likely never happen.

The big tax break for capital gains is what makes life as a mid-term flipper possible. There were many people during the bubble who bought with intention of flipping in two years when their gains would not be taxed. Of course, this tax strategy took second place to the pandemonium of the crazy market rally.

Favorable capital gains tax treatment is really a tax-free retirement savings account Uncle Sam worked into the system to benefit homeowners. If you own a property long enough to have capital gains, and the sale of that home represents a significant portion of family savings (which is usually does), the capital gains tax benefit can have significant financial impact on your financial life in retirement.