Inflation can hurt homeowners with taxes, home insurance

Home prices historically tend to increase when the Consumer Price Index is pushing higher, as is the case now. Over roughly the past year, for example, U.S. inflation has increased 8.3% and housing prices have shot up 20% or more in many markets. In fact, housing costs are a key component that affect the rate of inflation.

However, rising prices and inflation don't benefit homeowners in all respects. Below are some caveats homeowners should keep in mind involving taxes and insurance.

Inflation can make home gains taxable

People who sell their homes can exclude all or part of the gain from taxation. But unlike many provisions in the tax code, the dollar value of exclusions hasn't changed in 25 years, meaning these amounts have not increased with inflation. Yet home prices have risen substantially over that span. As a result, more owners are sitting on profits that could be partially taxable.

Taxpayers who sell a primary residence can exclude up to $250,000 in gains from taxation if single and $500,000 if married and filing jointly – numbers that have been in place since the Taxpayer Relief Act of 1997. If you can exclude the entire gain, you don't need to report the transaction on your tax return unless you received a Form 1099-S, according to the Internal Revenue Service. If you can't exclude the entire gain, you must report the transaction.

To claim an exclusion and avoid some or all taxes, homeowners must meet two tests. During the five-year period ending on the date of sale, you must have owned the home for at least two of those five years. In addition, you must have lived in the dwelling as your primary residence for at least two of those five years.

The tax rules on this topic can be tricky. IRS Publication 523 includes worksheets for figuring your taxable housing gain, if any.

Inflation can lessen insurance coverage

Most homeowners apparently haven't taken steps to make sure their coverage is keeping pace with inflation and rising building costs.

Only 30% of insured homeowners have purchased more insurance or increased coverage limits to compensate for rising building costs, according to a recent survey of more than 1,000 adults by the American Property Casualty Insurance Association. Among survey respondents who completed renovations or remodels during the pandemic, only 40% updated their policies to account for their higher home values.

"It is critical that homeowners make sure they have the right amount and right types of coverage during this period of significant inflation," said Karen Collins, assistant vice president of personal lines at APCIA, in a statement. "But unfortunately, our survey shows that many individuals may not be properly prepared."

Inflation, supply-chain disruptions and increased demand for skilled labor and materials have driven up rebuilding costs, which jumped 44% over a recent 12-month stretch.

Among survey findings, 63% of insured homeowners said they have not added or aren't sure if they have added annual inflation-adjustment coverage, which adjusts policies each year to account for inflation. Also, 67% haven't added or aren't sure if they have added extended replacement-cost coverage, which increases the coverage to rebuild if labor and materials expenses skyrocket after a natural disaster.

Inflation can make deductions elusive

Homeownership is touted as offering great tax breaks, and that can be the case. Yet most owners aren't making use of these tax benefits, partly because of inflation.

Owners who itemize may deduct property taxes and mortgage interest on a primary residence, and some do. However, property taxes often can't be deducted in full because they are included in the SALT category, which covers state and local taxes. The SALT deduction is capped at $10,000 annually, for both singles and married couples, and it's not indexed to inflation.

Meanwhile, the standard deduction has gotten more generous in recent years, and it is indexed to inflation. This tax break has risen steadily in recent years to $12,550 for singles, $18,800 for heads of household and $25,100 for married couples.