President Clinton and Congressional Leaders came together for the signing of the Balanced Budget and Tax Agreement on Tuesday, August 5,1997. We all know that anything produced by government is going to be massive in volume as well as in effect. At this time, I will address one aspect of the agreement that will be of particular interest to homeowners. Thus far, home sellers over 55 were eligible for a $125,000 exclusion of capital gains on the sale of their primary residence. If an individual were not 55, he or she had to use IRS rule 1034 (replacement of primary residence of equal or greater value) to avoid capital gains taxes on the sale. This replacement had to take place within a two-year period. Now this provision is no longer operative.
Retroactively effective as of May 6, 1997, a home seller can realize capital gains on a primary residence of up to $250,000 as a single tax payer and $500,000 as joint filers without incurring any tax liability. The only provision required is that the home must have been the primary residence of the seller(s) for the preceding two years. There is no longer the requirement to have lived in the home for three of the past five years as needed for the $125,000 (for joint filers) exclusion. This may be good or bad news depending upon your situation.
Another beneficial aspect is that there is no age factor to be considered. You do not have to be 55 or older to take advantage of this benefit. What is good about this provision is that this law gives one the opportunity to change residences every two years without penalty of capital gains tax. So if your situation changes unexpectedly, such as job transfer, loss of a job, an unfortunate illness or a death you will not have the dire prospect of a tax liability just because you sold your home at a gain.
Let's say you purchased a home in 1970 for $75,000 and moved up periodically using the 1034 replacement option. Each time you moved up you deferred capital gains because you purchased a home at a price higher than the preceding home. You now come to that point in life when you determine downsizing of residence is in the cards. According to the old law, all of the deferred profits on previous purchases are taxed excepting the $125,000 exclusion. With the new law you can now exclude $500,000 of gain. Even if you find that the $500,000 is insufficient to cover your capital gains on your primary residence, you will not feel the tax bite as much since the capital gains tax rate is now a maximum of 20% vs. 28% under the old law.
Notwithstanding the good news about real estate capital gains tax relief, there is one area of importance to many homeowners not included in the current agreement. Many people today are selling or have sold their homes at a loss. House Ways and Means Chairman Bill Archer and Senate Leaders on both sides of the aisle held out hope that help was on the way for sellers who sell their home at a loss. The anticipation was that these sellers would be able to deduct the loss on their tax returns. This did not happen. I also believe it will not be reconsidered soon. Since both the President and Congress have committed to a balanced budget by the year 2002, any future tax relief as to these losses, viewed as too costly, will either take from other spending interests or impact overall tax reductions. There is an element of tax unfairness in this scenario since gains are taxed when you sell at a profit, but losses are not deductible when you sell for less than you paid. Should not real estate investment losses and stock losses be treated equally when it comes to taxes?
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