President Trump recently proposed another tax cut — this one for homeowners of expensive property.

Currently, the principal residence profit exclusion allows home sellers who have lived in their home for at least two of the last five years to exclude up to $250,000 (single-filers) or $500,000 (married, filing jointly) of the profit from a home sale from being taxed. The remainder is taxed at the capital gains rate. [26 United States Code §121]

For most homeowners, this tax rate is currently limited to 15% of the portion of the gain exceeding the threshold. For homeowners with incomes over $418,400 (single-filers) or $470,700 (married, filed jointly), the maximum capital gains rate is 20%. Homeowners in the 10% and 15% tax bracket pay no tax on any gain exceeding the threshold.

However, the capital gains ceiling of $250,000/$500,000 has been criticized, since the ceiling remains the same from year-to-year, despite home price increases. Thus, as prices continue to increase, sellers’ profits increase. The result of higher profits is more capital gains tax.

Editor’s note — Read more about the many rules and exemptions on capital gains at the IRS website.

Prime beneficiaries of the proposal

Unsurprisingly, California homeowners stand to benefit the most from this proposal due to our state’s infamously high home values.

Zillow analyzed the impact such a proposal would have on homeowners in the largest 225 cities across the U.S. Half of the cities where the average home seller would benefit were located in California.

Consider a typical home seller who has owned their home for 20 years. When selling in 2018, if the capital gains rate was indexed to inflation rather than static as it is today, the typical seller would save of their tax bill:

  • $49,500 in Palo Alto;
  • $46,400 in Newport Beach;
  • $43,100 in Cupertino; and
  • $32,200 in Redwood City, according to Zillow.

These are large dollar amounts. But considering the average home sale price in these cities averages $2-$3 million, the numbers are slightly less impressive.

The really big impact is actually found outside of the housing market, as this proposal isn’t only to do with helping out homeowners in expensive states like California.

The proposed change is to account for inflation in determining profit on all capital gains. This includes other investment income like stocks, bonds and other assets. Thus, the proposal won’t just impact the occasional home sale, which for most homeowners occurs just a couple times in a lifetime. Far beyond the average homeowner, the vast majority of the change will impact very wealthy investors.

In fact, 63% of the money saved due to indexing capital gains will benefit the top 0.1% of income earners. This translates to a $102 billion loss in federal tax revenue in the next ten years, according to Bloomberg News. Put another way, this would mean an additional $62+ billion in the pockets of the 0.1% in the coming decade alone.

If legislators wanted to focus on helping homeowners, they might consider limiting their increase to the capital gain ceiling to home sales. But that proposal is not on the table.

How likely is it that Trump’s proposal will become law?

It’s hard to say. Trump has claimed he’s exploring ways to skip congressional approval and simply issue a new regulation that will index capital gains to inflation. But this will undoubtedly be challenged by detractors. Stay tuned as the situation develops.