A federal tax change that could mildly improve the housing situation.

[MyGodWearsAHoodie]

This was inspired by the Florida thread, but is different enough to go in a different thread....

The rule regarding not paying capital gains on sale of a you house purchased....

You can exclude up to $250,000 of profit if you file as single, or up to $500,000 if married filing jointly. The Test: You must have owned and lived in the home as your main house for at least 2 out of the 5 years before the date of sale. Frequency: You can use this exclusion once every 2 years.

The rule regarding capital gains of a house you inherit....

When you sell an inherited house, you only pay capital gains tax on the profit made above a "stepped-up basis," which is the fair market value of the home on the day the previous owner died. Inheriting the home itself is not taxable. If you sell it quickly for that same value, you will owe zero capital gains tax.

As written the tax code is very favorable to house flippers allowing them to earn up to $250k per year without paying any tax.  While they for the most part make the housing market less affordable for ordinary people.  Even if all of the increase in value of the house comes from their labor then they essentially are running a tax-free home improvement business. (separate issue)

But it can be problematic for a widow who has own the same home 50 years and whose house has increased by significantly more than $250,000 in the past 50 years. 

Here is what I propose...  If someone has (1) owed the house for more than ten years; (2) filed jointly for at least 5 of the last 10 years and (3) whose spouse died in the last 3 years.....then they get the $500k exclusion instead of the $250k. 

Here is my thinking.  (yes, some of it is a bit sexist)

Take the following hypothetical situation:

Couple buys house for $35,000.  After 50 years the house is now worth $435k.  Wife would prefer to move to a condo.  Husband would prefer to stay in the house.  They don't really need the space, but the husband likes the large garage and now that he is retired, he has time to work on restoring the '57 Mustang he bought 20 years ago.  She relents after all he does all the yard work etc and her primary reason for wanted to move is eliminated mowing the grass, cleaning the gutters, all stuff he does. Although climbing the stairs is getting more and more difficult. Plus it is kinda nice having the space for visitors.     

He dies.  She needs to now hire people to mow the lawn, paint the house, clean the gutters etc.  She has some emotional connection to the house she wants to move into a condo or senior independent living community.  She then learns about the capital gains tax and is PISSED OFF.  YOU MEAN IF WE HAD SOLD THE HOUSE AND MOVED WHEN I WANTED TO I WOULDN'T HAVE TO PAY CAPITAL GAINS TAX BUT NOW I WILL OWE $22,500.  She can afford the $22,500.  And it would still make financial sense for her to sell, rather than paying people for every minor fix and yard work.  But it is principle of the matter.  She doesn't want to a pay tax that she could have avoided if her husband had just listened to her 5 years ago she wouldn't have.  And she learns she can avoid the tax, but not selling at letting her kids sell it when she dies.  So she stays with the idea that she will stay as long as she is physically capable.  She considers getting a stairlift. 

My alternative....
He dies. The house is too big.  After a few months of hiring people to do all the things her husband did, she look into selling.  But she is still a little emotionally attached to the house, but it is kinda overwhelming.  She is considering staying while she is able, but climbing the stairs is more and more difficult every day.  She then learns of her tax situation.  If she sells within the next two and half years she won't have to pay capital gains tax.  But if she waits she will have to pay tax.  And it is only a matter of time before climbing the stairs goes from being difficult to being impossible.  So she starts looking for a new place to live.  And has a firm timeline so she doesn't put it off.       

An even better plan would be to limit how much you could exclude based on the number of years you owned the property.  Say $15k per year.  That way flippers would have to pay their fair share of tax, but someone who owned the same home for 50 years could excluded $750k greatly reducing the incentive to remain in an oversized appreciated house. 

[masterfins]

Just a note for your example, the surviving spouse has 2 years after death to sell the house and still qualify for the $500,000 exclusion.

Also if the residence was jointly owned then the surviving spouse receives a step-up in basis for the deceased spouses 50% value on the date of their death, this greatly reduces the amount of the taxable gain. (As long as it IS in a noncommunity property state. Community property state [Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin] do not get this break.)

[masterfins]

As written the tax code is very favorable to house flippers allowing them to earn up to $250k per year without paying any tax.  While they for the most part make the housing market less affordable for ordinary people.  Even if all of the increase in value of the house comes from their labor then they essentially are running a tax-free home improvement business. (separate issue)

Well it can only be done every two years, and you have to be in a market where the value is really growing substantial every year to get a maximum benefit.  If the market starts falling you get stuck.

[MyGodWearsAHoodie]

Well it can only be done every two years, and you have to be in a market where the value is really growing substantial every year to get a maximum benefit.  If the market starts falling you get stuck.

Forget the market growing.  Take a person who is a carpenter by trade, if he gets hired by other people and makes $250,000 per year he will have to pay income tax on that money.  On the other hand if he buys a run down house, and improves the house and sells it, he gets the income tax free.  That's not true of some one in almost any other business.  Someone who restores cars, antique furniture, or musical instruments all pays taxes.