The 1997 Tax Trap Hitting Home Sellers in South Dakota — And What You Can Do Before You List

If you've owned your home long enough to raise kids in it, refinance it once or twice, or just watch the neighborhood change around you — the federal government may have a claim on your equity you never expected.

In South Dakota, 25.4% of homeowners have built up more gain than the IRS lets them keep tax-free when they sell.^[1] Another 4.4% have crossed the $500,000 threshold for married couples — potentially triggering one of the largest tax bills of their lives.^[1] Nationally, the projected average federal tax liability for those who exceed the cap: $74,708.^[1]

That number isn't for million-dollar Silicon Valley homeowners. It's hitting people in Sioux Falls, Rapid City, and Brookings who bought their homes when they cost well under $200,000.^[1]

Why a No-Income-Tax State Doesn't Protect You

South Dakota is one of the few states that doesn't tax capital gains.^[1] But that protection stops at the state line. The tax at stake here is federal — and it comes from a provision that has been frozen at 1997 levels for nearly three decades.

Under IRS Section 121, you can exclude up to $250,000 in gain from the sale of your primary residence if you're single, or $500,000 if you're married filing jointly — but only if you meet ownership and use tests.^[2] Those dollar caps are the same ones that applied when Bill Clinton was president, home prices in much of the country were below $150,000, and the internet was something you plugged into a phone line.

Since then, national home prices have risen more than 260%.^[1] In South Dakota, appreciation has done what steady incomes never quite managed: pushed ordinary homeowners past federal tax thresholds they never knew existed.^[1]

The Numbers Behind South Dakota's Exposure

South Dakota's 25.4% exposure at the $250,000 single threshold is modest compared to California or Colorado.^[1] But it outpaces most neighboring states — Iowa sits at just 9.8%, North Dakota at 16.7%.^[1]

Where South Dakota stands out is the $500,000 couple threshold. Its 4.4% rate is double Nebraska (2.3%), ahead of Minnesota (3.7%), and even higher than Pennsylvania (3.4%) — a state where homes typically sell for significantly more.^[1] That means two-income couples who bought modest homes in the 1990s and held onto them through South Dakota's steady appreciation are landing in an unexpected tax situation.

The math works like this: if you bought a home in Sioux Falls for $135,000 in 1998 and sell it today for $395,000, your gain is $260,000. The IRS lets you shelter $250,000. The remaining $10,000 is taxable — and if your income puts you in a 15% long-term capital gains bracket, that's $1,500 in federal taxes on a single transaction you may not have budgeted for. Scale that up to a $600,000 sale price on a home bought for $175,000, and you're looking at $77,500 in taxable gain — potentially $11,625 or more owed to the IRS.^[2]

How the IRS Calculates What You Owe

The taxable amount isn't based on your home's sale price. It's based on your gain — the difference between your adjusted basis in the home and the sale price.^[2] Your basis starts at what you paid, then gets increased by capital improvements (new roof, room addition, major system replacements) and reduced by depreciation taken if you used part of the home for business or rental.^[2]

If your total gain exceeds the applicable exclusion, the excess is taxed as long-term capital gain — assuming you owned the home more than one year, which most primary residence sellers do. You report it on Form 8949 and Schedule D with your federal tax return.^[2]

The IRS provides worksheets in Publication 523 to walk through the calculation step by step.^[2] Most sellers never look at them until after they've already signed a purchase agreement and are staring at closing.

Why This Creates a "Stay-Put Penalty"

Housing advocates use this term for a reason.^[1] When a retiree in Rapid City realizes that selling the family home to right-size or relocate will trigger a $40,000 IRS bill, the rational decision is often to stay. So the house stays off the market. Supply tightens. A younger family loses an option they could have afforded.

This isn't a problem limited to high-cost coastal markets anymore. Once concentrated in a few expensive ZIP codes, capital gains tax exposure is reaching into smaller cities and rural communities across the country.^[1] The same dynamics pushing South Dakota past national averages are repeating in Midwest towns from Iowa to Ohio.^[1]

NAR's research shows that nearly 29 million homeowners — 34% of all U.S. homeowners — already face potential capital gains taxes if they sell today.^[4] By 2030, that figure is expected to reach 56%, and by 2035, nearly 70% of all U.S. homeowners could exceed the $250,000 cap.^[4] The $500,000 threshold will affect over 38% of homeowners.^[1]

What Congress Is Doing About It — And Why It Matters to You Now

Several members of Congress, including members of the Congressional Real Estate Caucus, sent a letter to Treasury Secretary Scott Bessent in March 2026 urging the department to use existing executive authority to index capital gains calculations to inflation.^[4] The National Association of REALTORS® has backed the bipartisan More Homes on the Market Act, which would double the capital gains exclusion limits and tie them to inflation going forward.^[1][4]

Those changes haven't happened yet. Until they do, the 1997 caps remain in effect — and appreciation continues to push more homeowners past thresholds that were already outdated a decade ago.^[4]

"Building equity shouldn't come with a penalty; it should come with opportunity," said Shannon McGahn, NAR's chief advocacy officer. "Congress intended to incentivize homeownership, not hit middle-class families with what increasingly amounts to a home equity tax."^[4]

Three Things to Do Before You List Your South Dakota Home

1. Calculate your adjusted basis now — before you talk to a buyer. Pull your original closing documents to find what you paid. Add up qualifying capital improvements (new windows, HVAC, roofing, permanent structures) using receipts or contractor records. The IRS worksheet in Publication 523 walks through this line by line.^[2]

2. Run the gain-and-exclusion math before you set a price. If your gain minus your basis adjustments exceeds $250,000 (single) or $500,000 (joint), part of your proceeds isn't yours to spend — it belongs to the IRS. Factor that into your minimum acceptable offer.

3. Talk to a tax professional before signing, not after. A CPA or tax attorney can identify which improvements count, whether a partial exclusion applies (available if you sold due to health, job change, divorce, or other qualified reasons), and whether timing your sale into a lower-income year reduces your bill.^[2] This conversation costs a few hundred dollars. Discovering an unexpected five-figure tax liability at closing costs far more.

South Dakota's lack of a state income tax doesn't insulate you from this. No exemption exists in a law that was written for a housing market that no longer exists. The equity you've built is real — but so is the bill that may come attached to it.

Know the number before you sign.