A Call to Action: Reform the Capital Gains Tax

Ryan Heshmati

March 21, 2024

As tax season comes around in 2024, in addition to federal and state income taxes, many Americans have yet another tax consideration: capital gains taxes. Depending on income, the long-term capital gains rate (applied to sales of investments held for over one year) varies from 0% to 20%. As Americans age, nearing retirement, capital gains taxes become of greater concern as their appreciated, long-held assets like stocks, bonds, and real estate will be subject to the tax and could complicate access to funds retirees plan to live off of. The capital gains tax has certain exceptions, but nevertheless, there is a serious reason to call for reform.

Take a primary residence, for instance. While investment properties with capital gains can be sold without capital gains liability through 1031 exchanges (which defers the capital gains), as long as certain requirements are met and the proceeds go to purchasing another investment property, the same opportunity is not available for primary residences. Suppose a couple seeks to relocate in retirement and sell a long-held appreciated home, purchasing a home of equal value in their retirement destination. In that case, there is no option to avoid capital gains taxes. The federal government does offer an exemption on the first $500,000 in profits from the sale of a couple’s primary residence, but that figure means a lot less than it once did with sky-high property values in many high-cost-of-living areas.

Another problem with the capital gains tax applies to all assets subject to this form of taxation: inflation. For capital gains tax calculation purposes, the government only cares about the nominal cost basis for the asset and the nominal sale price. However, if an asset has been held for a long period of time, typical for those subject to the long-term capital gains tax, inflation will make an impact even though the government does not factor it in. For instance, if an individual bought 20,000 shares of stock in January 2000 for $100 and sold it in December of 2023 for $182 per share, the $82 per share difference would be considered long-term capital gains and taxed. During the same period, however, the Bureau of Labor Statistics inflation data indicates that the $182 stock cost the same in December of 2023 as it did in January of 2000 once adjusted for inflation. While living in a world whose costs are filled with the effects of such inflation, the investor will not receive any relief from the taxman and would be hit with a bill in the hundreds of thousands of dollars; thus, the investor would be penalized simply for keeping pace with inflation.

Both capital gains tax rules on primary residences and inflation should be considerations lawmakers consider on the subject of tax reform. Unfortunately, with a deeply divided government, the question of whether reform addressing these issues will ever come remains unclear.