1 The Effect of the Capital Gains Tax on the Intertemporal Housing Demand

Special provisions in the tax code of some countries enable homeowners to waive tax payments on the capital gain from selling their previous house if they buy a new house of equal or greater value within a short period time of when they move. Owing to this special tax treatment on the capital gain, house owners often face a kinked budget constraint. This paper incorporates this special capital gains tax treatment into the two-period intertemporal housing demand framework. We assume individuals may have a certain degree of myopia on the tax treatment on the beginning of the first period in which the first house decision is made. However, they will become knowledgeable on the tax treatment as well as the stock of previous house when the second house decision is made on the beginning of the second period. Optimal solutions obtained from traditional intertemporal optimization framework suggest that the capital gains tax rate generally has a negative effect on the optimal first-period housing consumption, while it generally has a positive effect on the optimal second-period housing consumption. However, the optimal second-period housing consumption should be modified when the information of tax treatment and previous house stock becomes available on the beginning of the second period. We find the previous house stock has a negative effect on the modified second period housing consumption. The influence of the capital gains tax rate on the modified second period housing consumption becomes ambiguous