This post was motivated by President Trump’s recent list of ideas aimed at stimulating housing supply, one of which involves changes to capital gains taxation. Housing lock-in is real—but capital gains reform can’t be designed around housing alone. Any serious reform has to grapple with revenue, step-up in basis, and the treatment of other assets, not just owner-occupied homes.
Executive Summary
Capital gains taxation in the United States is widely debated, but poorly designed. The current system combines relatively high taxes on people who sell appreciated assets with near-complete exemption for gains held until death. This structure discourages asset sales, suppresses market activity, and distorts economic decision-making—most visibly in the housing market.
Older homeowners, with substantial unrealized gains face large tax liabilities if they sell, often remaining in their home until death to allow their heirs to escape capital gains taxes entirely. The result is reduced housing turnover, fewer homes for sale, and diminished mobility.
Relief for homeowners cannot be designed in isolation; a coherent reform must balance mobility, fairness, and revenue by pairing targeted reductions in capital gains taxes on primary residences with base-broadening reforms elsewhere in the system. Capital gains reform should also be evaluated in the context of long-term financing for Social Security and Medicare rather than solely as a general revenue question.
The Problem: How Capital Gains Taxes Freeze Markets
Capital gains taxes differ fundamentally from taxes on wages or consumption. Asset sales are voluntary, and higher statutory rates do not translate one-for-one into higher revenue. Instead, higher capital gains tax rates discourage realizations, leading many taxpayers to delay or avoid selling appreciated assets altogether.
This behavior has broad economic consequences. When assets remain locked in place, capital is allocated less efficiently, market liquidity declines, and economic adjustment slows. These effects are well documented in financial markets, but they are especially pronounced in housing.
Unlike stocks or bonds, selling a principal residence is often driven by life events such as retirement, changes in health, family needs, or job relocation. Tax policy therefore plays an outsized role in shaping housing mobility.
Although current law allows the exclusion of a portion of capital gains on the sale of a principal residence, long-tenured homeowners—particularly in high-cost markets—often face large taxable gains. When combined with the net investment income tax, the resulting liability can materially influence whether a household chooses to move at all.
The step-up in basis at death eliminates capital gains taxes entirely for heirs. These tax rules can incentivize some people to stay put even when downsizing or relocating would otherwise be economically or personally rational.
The combined effect is a reduction in housing supply, particularly among larger and higher-value homes. Fewer properties come to market, transaction volume declines, and housing-related economic activity is suppressed. These dynamics worsen affordability pressures for younger households and first-time buyers.
More broadly, the current capital gains system rewards inactivity and penalizes liquidity. Taxing gains heavily when assets are sold, while fully exempting gains held until death, discourages turnover across both housing and financial markets and freezes assets in place rather than allowing them to be reallocated to higher value uses.
This behavioral response is not speculative. A substantial body of empirical research—much of it developed by Treasury economists in the late 1970s and early 1980s—examined how capital gains tax rates affect realizations, asset turnover, and revenue. That literature consistently found that higher capital gains tax rates reduce realizations, sometimes sharply, and that projected revenue gains from higher rates are often significantly offset by reduced transaction volume. While estimates varied, the central conclusion was that capital gains taxes have unusually large behavioral effects relative to many other forms of taxation.
Most of that early work focused on financial assets rather than housing, but the underlying mechanism is the same: when selling is discretionary, higher tax rates induce taxpayers to defer transactions, alter portfolios less frequently, or avoid realizations altogether. In housing, where transactions are less frequent and gains are often larger and less divisible, these lock-in effects may be even more pronounced.
Recent proposals to substantially increase capital gains tax rates, including those advanced by the Biden and Harris campaigns, tend to emphasize statutory progressivity and projected revenue gains while placing less weight on behavioral responses. In particular, these proposals generally assume that higher rates will yield large and predictable increases in revenue. However, if higher rates discourage a meaningful share of transactions—as the earlier literature suggests—the realized revenue gains may be considerably smaller than anticipated, while the adverse effects on housing turnover, asset mobility, and market liquidity may be substantial.
As a result, debates over capital gains taxation should not be framed solely as questions of fairness or statutory rates. They also hinge on how sensitive asset sales are to taxation and whether higher rates ultimately raise meaningful revenue or instead reinforce lock-in, suppress transactions, and reduce the economic dynamism of both housing and financial markets.
The remainder of this memo develops a coherent capital gains reform framework that addresses housing lock-in while preserving revenue, improving neutrality across assets, and strengthening long-term financing for Social Security and Medicare. The paid section also includes a substantive, curated reading list for readers who want to explore the academic, Treasury, and official-sector literature on capital gains taxation in greater depth.
