The Tax Trap That's Freezing the Housing Market

Home sales in Virginia have declined by over 3% in the past year, particularly in Southwest Virginia, the New River Valley, Blue Ridge, and Dan River regions.

A common complaint among buyers is that there simply aren't enough homes on the market. Homeowners are staying put, and this puts a crimp on inventory. While higher mortgage rates get most of the blame, another culprit is contributing to the dearth of options: the U.S. tax code.

A recent report from Moody’s Analytics, led by Chief Economist Mark Zandi and Deputy Chief Economist Cristian deRitis, points to outdated capital gains tax rules as the reason millions of homes are being kept off the market — homes that growing families and first-time buyers desperately need.

What’s going on?

Many older homeowners — especially empty nesters — are "locked in" to homes that are too big for their current lifestyle. While they may want to downsize, selling could mean a massive capital gains tax bill, erasing too much of the equity they spent years building in their home.

This is especially brutal in high-cost areas like Richmond, Charlottesville, and Northern Virginia, where even a modest home bought decades ago has appreciated so much that selling it could trigger six-figure tax liabilities. According to Moody’s, nearly 6 million older Americans are living in homes much larger than they need, while younger families are squeezed into too-small spaces or stuck renting longer than they planned.

The outdated tax rule behind it all

The blame lies with the Taxpayer Relief Act of 1997, which lets homeowners exclude up to $250,000 in capital gains from their home sale (or $500,000 for couples). That might’ve been generous in the '90s, but it hasn’t been updated since — despite massive home price growth.

If the rule had kept up with the market, the exclusion would now be around $885,000 for singles and $1.77 million for couples. But since it hasn’t, homeowners thinking about selling are calculating that they will get hit with tax bills they can’t afford.

Real example: Why Grandmother's not selling

Moody’s uses a relatable example: imagine a widow living in a 3,000-square-foot home with $750,000 in capital gains. After her $250K exclusion, she could owe over $100,000 in taxes, which is more than 20% of what she’d make from downsizing.

So she stays put. When she passes, her heirs inherit the house with a new “stepped-up” tax basis — meaning no one pays the tax. This does not help the housing supply, and it is stressful for the Grandmother who has more house than she can comfortably manage.

What’s the fix?

Zandi and deRitis argue that updating the tax exclusion — indexing it to inflation or home price growth — would free up a massive amount of inventory. That means more homes for families and first-time buyers, and more flexibility for older homeowners to move when they want to.

And it’s not just about homes. More housing turnover means greater labor mobility. If people can move for jobs without huge financial penalties, local economies benefit. Plus, all that buying, selling, remodeling, and moving activity would pump new life into the broader economy.

Not a tax break for the rich

Changing the code isn’t a giveaway to the wealthy. Moody’s points out that middle-income homeowners in expensive areas — especially after events like divorce or the death of a spouse — are the ones getting hit the hardest. High earners often have ways to work around the tax system entirely.

By modernizing the rule, we’d be helping regular homebuyers — not speculators or investors.

Opponents to changing the code argue that doing so could crash the housing market. Zandi and deRitis, however, note that even if listings jumped by 25%, the housing market would only be returning to normal, pre-crisis inventory levels. In addition, a time-limited adjustment (think: 3–5 years) could kickstart the market without disrupting prices.

Homebuyers still can’t catch a break

It’s no secret that those in the market to buy are getting into homeownership way later than previous generations. In fact, the median first-time buyer is now 38 years old, and boomers are outpacing both Gen Z and millennials in home buying — often paying in cash.

Boomers hold the cards. They own over half the homes in America, and most of them don’t have a mortgage anymore. That gives them the freedom to stay put — or tap their equity to fund retirement — while younger buyers get priced out and stuck in place.

Financial analyst Meredith Whitney believes this dynamic will shape the housing market and the U.S. economy for the next several years.

Sources: Fortune, Forbes, Moody's Analytics, NAR