For more than 50 years, capital gains on sales of taxpayers' homes have been preferentially treated. A revision in 1997 replaced two longstanding provisions—a provision allowing capital gains tax deferral when a new residence is purchased and a one time exclusion of $125,000 of capital gains for sellers over age 55—with a capped exclusion for each sale. While the 1997 cap was higher than the previous cap for the over-age-55 sellers, it was less generous than the uncapped rollover provision it replaced. In addition, the dollar cap was not indexed for price changes, and, unlike the previous over-age-55 cap, was half as large for unmarried taxpayers—$500,000 for married couples and $250,000 for single taxpayers. The exclusion is allowed once every two years, subject to taxpayers meeting ownership and use tests. The ceiling was presumably meant to eliminate any capital gains tax on home sales for the vast majority of taxpayers, but the rapid rise in housing prices and the passage of time have reduced the value of the exclusion. With no revision and a continued upward march of housing prices, an increasing share of gains will be subject to tax. Two bills in the 109 th Congress addressed this provision. H.R. 2127 , introduced by Representative Filner, would have allowed taxpayers over the age of 50 to exclude an amount that is double the current cap, but it is available only once in their lifetime. H.R. 2757 , introduced by Representative Andrews, would have indexed the exclusion. Other legislation ( H.R. 3803 by Representative McCarthy and S. 4075 by Senator Schumer) was introduced to change the amount of the exclusion for surviving spouses to that of a married couple. In the 110 th Congress, S. 138 was introduced to allow a surviving spouse to exclude up to $500,000 of gain from the sale or exchange of a principal residence owned jointly with a deceased spouse if the sale or exchange occurs within two years of the death of the spouse. That provision was also included in H.R. 3648 , the Mortgage Forgiveness Debt Relief Act of 2007, which became public law ( P.L. 110-142 ) on December 20, 2007. This report examines the capital gains exclusion and the ceiling. The first section describes the current tax rules, and the second section presents the historical development of the capital gains provisions. The third section discusses potential justifications for capital gains relief, as well as tax avoidance problems that may arise. The final section discusses various options for change, primarily focusing on the dollar ceiling. The modification to current law enacted by the Mortgage Forgiveness Debt Relief Act of 2007 is also addressed in the final section. When an individual sells a personal residence, the excess of the sales price over the original cost plus improvements is a capital gain and is subject to tax. The individual is able to deduct any costs of the sale (such as commissions and advertising), and may also be required to include gain that was deferred from previous home sales. Gain up to $250,000 for single taxpayers and $500,000 for married couples filing joint returns is excluded if the taxpayer meets a use test (has lived in the house for at least two years out of the last five years) and an ownership test (has owned the house, also for two years out of the last five). The use and ownership years may be the same or different. The exclusion can be used every two years. In order to minimize the tax, assuming the individual is subject to it, he or she must keep records of any improvements during the entire time the home is owned and also, to comply with the law, appropriately distinguish between expenditures that are repairs, which do not reduce gain, and those that are improvements, which do reduce gain. For homes that were acquired before the 1997 change in tax law, there may also be deferred gain from previously owned residences. Under pre-1997 tax law, a taxpayer could defer the gain on a home sale if another residence was purchased. If the new residence cost as much or more than the old residence sold for, the tax on the entire gain was deferred. If the new residence cost less than the sale price of the old residence, gains tax was due on the difference between the value of the old and new residence (if less than the gain) and tax on the remainder was deferred. The additional gain from previously owned residences makes it more likely that total gains will exceed the cap; had the 1997 law been in place for many years, much or all of the prior gain would have been excluded. Capital gains on assets that are held at least a year are taxed at special, lower rates: 5% for taxpayers in the 10% and 15% marginal income tax brackets and 15% for taxpayers in marginal income tax brackets above 15%. These provisions are temporary. Although the 5% rate will be reduced to 0% in 2008, the lower rates will expire at the end of 2010, absent legislative change, and the rates will revert to their previous levels, generally 10% and 20%. A special relief provision for military families and the Foreign Service allows them to expand the five-year period for the ownership and use tests to up to 10 years while on qualified official duty. Another provision that may influence a taxpayer's decision about selling a residence is a long-standing provision that allows the gain to be forgiven entirely if the taxpayer does not sell the home and leaves it as part of his or her estate. If an individual keeps his house until death and leaves it to heirs, no tax on gain accumulated would be due, since the heir would be able to deduct the fair market value at time of death from sales price, when the house is sold (resulting in a zero capital gain with instantaneous sale). This rule is called a step-up in basis. The gain realized upon the sale of a personal residence was taxed as capital gain until the passage of the Revenue Act of 1951 (P.L. 82-183). At that time, Congress enacted a rollover provision that allowed for the deferral of capital gains tax if the proceeds of the sale were used to buy another residence of equal or greater value within a year before or after the sale of the old residence. Congress stated that the rollover provision was in response to transactions that were: necessitated by such facts as an increase in the size of the family or a change in the place of the taxpayer's employment. In these situations the transaction partakes of the nature of an involuntary conversion. Cases of this type are particularly numerous in periods of rapid change such as mobilization or reconversion. At that time, the economy had grown as a result of industrialization and residential moves were more frequent due to business transfers and other employment related changes. Congress also recognized that capital gains from home sales were, in part, a result of general inflation. During the congressional debate, the rollover provision was justified on the grounds that homeowners were changing homes, not to make a profit as investors, but rather in response to employment and/or family size changes. The first exclusion from taxation for capital gains on the sale of a primary residence was enacted by the Revenue Act of 1964 (P.L. 88-272). The provision was available only for the elderly (age 65 and over) and applied to residences sold after 1963. It was available on a one-time basis only, and was at the same level for both single and married individuals. To qualify, the house had to be occupied for five of the previous eight years. The exclusion of gain was limited to the amount attributable to the first $20,000 of sales price. Above that level, a ratio was used to determine the gain subject to taxation, such that the amount of the exclusion depended on the relationship of sales price to basis, as well as the relationship between $20,000 and sales price. For example, if the sales price were $40,000, one-half of the gain ($20,000/$40,000) could be excluded. But the actual amount excluded would be less than $20,000, unless the house originally cost $20,000. For example, if the basis in the house was $10,000, the gain on the $40,000 sale would be $30,000. Of that $30,000, one half, or $15,000, would be excluded because $20,000 was half the sales price. The reason given for the exclusion was to reduce the burden on elderly taxpayers who would have to tie up all of their investment in a new home to avoid paying capital gains tax. The dollar restriction was due to a focus on the average and smaller home, thus suggesting a distributional motive. The amount of capital gains excludable from taxation for older taxpayers was increased three times in response to higher housing prices. The three increases were enacted by The Tax Reform Act of 1976 ( P.L. 94-455 ), the Revenue Act of 1978 ( P.L. 95-600 ), the Economic Recovery Tax Act of 1981 ( P.L. 97-34 ) and finally, the Taxpayer Relief Act of 1997 ( P.L. 105-34 ). The limit for elderly homeowners rose to $35,000 in 1976, $100,000 in 1978, and $125,000 in 1981. The 1978 provision also liberalized the benefit by simply allowing an exclusion rather than a proportional share that depended on basis and lowered the age limit to 55. (There was consideration of eliminating the age requirement altogether.) The 1978 change also reduced the holding period requirement to three out of the previous eight years. In each case of capital gains relief, Congress cited the rising sale prices of homes as the source of large amounts of taxable capital gains on residences and the reason for adjusting the amount of capital gains that could be excluded from taxation. When the rollover provisions and one time exclusion for the elderly were replaced by the current exclusion (in the Taxpayer Relief Act of 1997, P.L.