Sunday, January 15, 2006

Why the Dramatic Rise Occurred

Why have home prices risen so dramatically in the United States in recent years?

Roughly five years ago the capital gains tax on homes was eliminated up to, I believe, $500,000. If you sell your home today and have a $300,000 gain, you keep all of it. If you have a $300,000 gain in a stock and sell today your subject to the 15% captial gains tax and only get to keep $255,000 (300,000 x 15% = $45,0000). Which is the better investment today? Clearly money has flowed into homes as a result of the tax change.

If the capital gains tax on stocks was also eliminated up to $500,000 does anyone doubt we would see a rise in stock prices?

The discrepency in price appreciation, at least in the area of the country in which I live, between lower and mid-priced homes vs very expensive homes also points to the elimination of the capital gains tax as a primary driver in the rise in home prices.

The town I live in has an average annual income of $70,000. In my town, home prices have risen, on average, by over 50% over the last few years. In the next town over, the average annual income is over $170,000 a year. Over the last two years, home prices have actually Declined in that town. Why?

The town is loaded with the so-called "Mcmansions". Large homes, on lots of acreage, that have been built within the last decade or two, that sell for a million dollars or more. Since the capital gains tax was eliminated only up to $500,000, the higher a home sells for, the more likely it is that the owner will have to pay some capital gains tax when the home is sold. Which has acted to keep the very expensive homes, the Mcmansions, from seeing the same kinds of price appreciation that more modestly priced homes have seen.

A home in the next town over recently went on the market for $1,300,000. The home was built a half-dozen years ago and went for just over $1,000,000 brand new. So if the owners get what they are asking, they will be getting, at best, a 30% gain. There are no homes in the next town over that were worth $1,000,000 five years ago and are today going for $1,500,000.

In the town I live in, virtually every home that was worth $300,000 five years ago goes for at least $450,000 or more today. A 50% or better rise in price appreciation.

The elimination of the capital gains tax (up to $500,000) has clearly played a key role in the rise in home prices in the US.


The fact that there is a reasonable, logical explanation for, at least in part, the dramatic rise in home prices over the last few years gives further proof that the US housing market is not experiencing a financial bubble that is in any way comparable to past historical financial bubbles.

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