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Here is a policy proposal that would likely help increase inventory in many areas (especially in high-cost areas) and would increase the utilization of the current housing stock.
Currently, when a property is sold, the IRS allows a $250,000 exclusion on the gain for an individual (or $500,000 for a joint return). From the IRS: Sale of Residence
If you have a gain from the sale of your main home, you may be able to exclude up to $250,000 of the gain from your income ($500,000 on a joint return in most cases).
To claim the exclusion, you must meet the ownership and use tests. This means that during the 5-year period ending on the date of the sale, you must have:
• Owned the home for at least two years (the ownership test)
• Lived in the home as your main home for at least two years (the use test)
For long term owners, especially in higher cost areas, their gains are significantly more than the allowed exclusion. However, if they keep the property until they pass away, their heirs receive the property on a step-up basis (to current market value) and there are no capital gains taxes.
These two IRS rules incentivize people to keep their home until they pass away. This causes assets to be underutilized. It is common to see an elderly couple, or single individual, living in a 4-bedroom home! This will probably become even more common as the baby boom generation ages.
A simple policy change would allow these people to downsize or move to a retirement home and increase the utilization of the property.
My suggestion is to allow people over 65 a one-time exclusion of all capital gains on the sale of their primary residence.
This would have little impact on tax revenue but would increase the utilization of the current housing stock. There would be other benefits - it would put money in the pocket of the seller to enjoy life, and it would likely lead to spending on improvements as the new owners renovates the home.
Just a suggestion …
A Policy Proposal to Increase the Utilization of the Current Housing Stock
The alternative is, of course, to end the step up at death rather than adding an additional exclusion. That said, adding exclusions is traditionally an easier sell.
I love this idea and (as a loan originator working in the trenches in a somewhat high-cost West Coast market) I can say your instincts are spot on. Older folks would be a lot more willing to downsize if they had a one-time unlimited exclusion.
I never see this discussed in the housing press or by analysts, but my instinct has always been that the change (in 1997) from the old "buy up or pay up" cap gains rules (with a one-time $125k exclusion for folks over 55) to the current $250k/$500k scheme may have been a slow-burning spark that played a role in the run-up to the housing crisis.
I started as a loan officer in 1994 and feel like it took 3 or 4 years before word got out as to the general public (information spread slowly in old-timey days of the early internet, especially among the slower-to-adopt technology older cohort). And then it took a few more years for the idea churning through houses every few years was a way to make a quick, tax-free buck. But once that ethos took hold and Wall Street/lenders and the real estate community fanned the flames with easy money ... well, we all know how that ended. As a person who makes a living helping folks with loans, I have benefited from the post-1997 mindset with regard to housing, so I'm not complaining.
And while I'm sharing random thoughts on the old rules: I'd guess part of the mobility of the workforce was attributable to the 1997 policy change. Moving from, say, the the Bay Area or Seattle to Columbus, would have come with a capital gains tax hit for many folks -- because "buying up" would be darned difficult to do. (I wonder how different folks moving around during COVID would have been under the old rules?)