When Congress passed the Taxpayer Relief Act of 1997, a three-bedroom ranch house in San Jose might have sold for $280,000. Today that same house could fetch $1.5 million or more. A single homeowner who held on for the full ride would owe federal capital-gains tax on roughly $750,000 of profit after applying the $250,000 exclusion, a tax bill that could easily reach six figures.
That scenario is playing out across dozens of high-appreciation markets. The federal capital-gains exclusion for a primary-home sale, codified in Section 121 of the Internal Revenue Code, has not been adjusted since the 1997 law set it at $250,000 for single filers and $500,000 for married couples filing jointly. In the nearly three decades since, home values and homeowner equity have moved sharply higher. CoreLogic’s Homeowner Equity Insights reports that median U.S. homeowner equity now exceeds $213,000, and for long-tenured owners in coastal and Sun Belt metros, typical gains blow past the exclusion caps entirely.
“The exclusion was generous when it was enacted,” said Mark Luscombe, a principal federal tax analyst at Wolters Kluwer Tax & Accounting, in a 2024 interview with Kiplinger. “But Congress never built in an inflation adjustment, and that decision looks more consequential every year.”
How the 1997 law works
Before Section 121, homeowners could defer capital gains on a sale only by rolling the proceeds into a more expensive property within two years. The 1997 act scrapped that rollover system and replaced it with a flat exclusion: sell your primary home, and the first $250,000 in gain ($500,000 for joint filers) is tax-free, no reinvestment required.
The qualifying rules are straightforward. A seller must have owned the home and used it as a principal residence for at least two of the five years before the sale. Married couples claiming the full $500,000 must file jointly; at least one spouse must meet the ownership test, and both must meet the use test. The exclusion generally cannot be claimed more than once every two years.
What Congress did not do is index the dollar caps to inflation or to home prices. According to the Bureau of Labor Statistics’ CPI inflation calculator, $250,000 in 1997 dollars is equivalent to roughly $495,000 as of early 2025 CPI data. That means the single-filer exclusion has lost nearly half its purchasing power. The joint exclusion, still set at $500,000, now barely matches what the individual cap alone would be if it had kept pace with consumer prices.
Where the gap hits hardest
The national median equity figure suggests the typical homeowner still fits within the single-filer cap. But that median masks enormous regional variation. Owners who purchased in coastal California, the Pacific Northwest, the Northeast corridor, or fast-growing Sun Belt metros during the early 2000s or after the 2008 downturn have often seen nominal gains far above $250,000.
Consider a married couple who bought a home in a high-cost market for $350,000 twenty years ago and sells it in 2026 for $1.1 million. Their gain, before adjustments for capital improvements, is $750,000. After applying the $500,000 joint exclusion, $250,000 is subject to federal capital-gains tax, typically at 15% or 20% depending on taxable income. For higher earners, the 3.8% Net Investment Income Tax under IRC Section 1411 can push the effective federal rate on that excess gain to 23.8%, before any state income tax applies.
State taxes compound the hit. California’s top marginal rate on capital gains is 13.3%. New York’s reaches 10.9%, and a New York City resident can face an additional local tax. A seller in one of these states whose gain exceeds the federal exclusion by $300,000 could owe a combined federal-and-state bill approaching $100,000 or more.
Single filers face a tighter squeeze. In markets where home values have doubled or tripled since the late 1990s, a $250,000 exclusion can be consumed by appreciation alone. The ownership and use tests do not scale with price, so meeting the residency requirement offers no additional protection once gains cross the statutory line. Many long-term owners who never considered themselves real estate investors now face five- or six-figure tax bills simply because they stayed in neighborhoods that became significantly more expensive.
What sellers can do right now
Current IRS guidance on home-sale gains outlines several rules that can affect the final calculation, and sellers who understand them have real room to reduce their exposure.
Increase your cost basis with capital improvements. The IRS allows homeowners to add the cost of capital improvements to their original purchase price, which directly reduces the taxable gain. Qualifying improvements include a new roof, a kitchen or bathroom renovation, an addition, a new HVAC system, or a finished basement. Routine maintenance and cosmetic repairs (repainting, fixing a leaky faucet) do not count. Tax advisers consistently recommend keeping receipts and contractor invoices for major projects throughout ownership, not just in the year of a planned sale.
Understand the partial exclusion. Sellers who fail the two-out-of-five-year residency test because they moved for work, health, or certain unforeseen circumstances may still qualify for a reduced, prorated exclusion rather than losing the benefit entirely. The IRS spells out the qualifying reasons in Publication 523.
Watch for depreciation recapture. Homeowners who claimed depreciation deductions for a home office or rental use of part of the property must recapture that depreciated amount as taxable gain, even if their total profit falls within the exclusion. The recapture is taxed at a maximum rate of 25%, separate from the capital-gains rate on the rest of the profit.
Consider the step-up in basis. For older homeowners weighing whether to sell or hold, it is worth knowing that heirs who inherit a home receive a stepped-up cost basis equal to the property’s fair market value at the date of death, under IRC Section 1014. That step-up can eliminate the capital-gains tax entirely if the heirs later sell at or near that value. This is not a reason to avoid selling, but it is a factor that belongs in the planning conversation.
One common question: can a homeowner use a 1031 like-kind exchange to defer the gain? No. Section 1031 applies only to investment or business property, not to a personal residence. A primary home sold at a gain above the exclusion is taxed in the year of sale unless the seller qualifies for an installment sale, which spreads the gain (and the tax) over multiple years.
Why Congress has not raised the caps
Despite the growing mismatch, no legislation to raise or index the exclusion has gained meaningful traction. In 2022, Rep. Jimmy Panetta of California introduced the More Homes on the Market Act (H.R. 7671), which proposed raising the caps to $500,000 for singles and $1 million for couples and indexing them to inflation going forward. The bill did not advance past introduction. As of mid-2026, no comparable proposal in the current Congress has reached committee markup or received a score from the Congressional Budget Office.
The political math is difficult. Raising the exclusion primarily benefits homeowners sitting on large gains, a group that skews wealthier and older. Any revenue estimate for expanding the exclusion would show a cost to the Treasury, making it a harder sell when deficits dominate budget debates. At the same time, the lack of indexing creates a slow-moving bracket creep that pulls more middle-class sellers into taxable territory with each passing year, particularly in high-cost states where housing appreciation has far outpaced national averages.
“It’s a classic case of legislative inertia,” said Howard Gleckman, a senior fellow at the Tax Policy Center, in a 2023 analysis. “Nobody set out to tax middle-class home sellers, but that’s increasingly what the statute does.”
A threshold that falls further behind every year
Without new legislation, the exclusion will continue to operate on its original 1997 dollar amounts even as home prices and equity pull further away. The IRS does not publish data on how many home sales each year produce gains exceeding the exclusion thresholds, so the precise scope of the problem remains undocumented at the federal level. What is clear from private-sector data and straightforward arithmetic is that the number of affected sellers grows each year the caps stay flat.
For homeowners approaching a sale, the burden falls on careful planning: tracking basis, documenting improvements, understanding the residency requirements, and consulting a tax professional well before listing. The Section 121 exclusion remains one of the most valuable tax benefits available to individual taxpayers. But for a growing share of long-tenured owners, it no longer covers the full gain. The distance between what the law allows and what the market delivers is widening, and right now, no fix is on the horizon.
David M. Keller is a finance writer based in Columbus, Ohio, covering personal finance and consumer-focused economic topics. He earned his degree in journalism from Ohio University and began his career reporting on local business and economic trends for a regional media outlet. Since then, he has contributed to a variety of online publications, focusing on clear, practical coverage of topics such as cost of living, debt, and everyday financial decision-making.
