How the 1995 Changes in Capital Gains Tax on Homes Plays out in Berkeley

I live in a neighborhood in North Berkeley where a lot of people bought their house 30 or 40 years ago when they were young.  They bought the houses at various times of course but generally the ones that have lived here the longest paid under $100,000.  The houses now sell for around a million dollars.

Their houses were relatively expensive when they bought 30 or 40 years ago, compared to housing in other parts of the state or country, and they are still relatively expensive compared to other parts of the state or country.  Relatively the value of the house hasn't changed, the big dollar increase is mostly simply inflation.  They haven't really gained much over all those years.

Before 1995 the homeowners in our neighborhood could have sold the house and as long as they rolled the money over into buying a replacement residence they would face no capital gains.  They could downsize to a smaller house and stay in the neighborhood where they have lived there whole life and where all there friends reside.  But Congress in 1995 threw out the old rollover rule that had been the law for at least 50 years.  Instead now when you sell your house you get a flat Capital Gains exemption of either $250,000 or $500,000, depending on whether you are married or single.  

That $250,000 / $500,000 exemption probably still works pretty good for folks in parts of the country where house prices have always been lower.  But it is crippling in the markets where housing is more expensive.  Older people who want to sell are staggared by the size of the potential capital gains tax, and the tax would effectively leave them without enough money to buy a new place in their neigborhood.  To move or downsize they would have to pay a big tax and then have to move somewhere cheaper to afford housing.   So they stay.   As a result almost no houses are for sale in our part of town, which means that when a house comes on the market, very wealthy folks sweep in and snatch it up.  A house a little further up the hill came on the market last year.  It was not in very good shape, so was offered at $600,000.  Almost immediately a developer stepped in, offered $950,000.  The developer prettied the house up and sold it a few months later for somewhere around $1,300,000.  

One of our elderly neighbors had to move into a residential care facility. Her children, who live out of town, couldn't sell the house to pay for the care because the tax obligation would have been so crippling.  So they are left renting the house, unable to sell the house until their mother dies, at which point they get a stepped up basis (so in the eyes of the tax man they don't have any gain) and the tax obligation goes away.

Berkeley, and I am sure a lot of other neighborhoods in this country, are tangled up in a classic catch 22.  Inflation, and the real estate bubble that the capital gains tax changes contributed to, has driven the price of the houses up to the point where many people can't afford to move.  So they don't, and the lack of inventory drives the prices up even higher, making moving impossible for even more people.  Young people can't afford to buy, older people can't afford to move.  

Thanks, Congress.