Tax relief on way in Congress

THE BALTIMORE SUN

AS THE HOUSE and Senate moved to complete work on their respective balanced-budget and tax bills last week, homeowners and real estate investors could begin to see how the two pieces of legislation would affect them.

For homeowners and sellers, both the House and Senate measures would scrap the current, complicated system of capital gains "rollovers" on home sale profits, as well as the current $125,000 tax-free exclusion on gains by sellers 55 years or older.

The bills would replace the existing system with a more generous approach that would essentially exempt most home sellers from paying any federal taxes on their gains, up to specified limits. Effective for transactions on or after May 7, 1997, married home sellers who file their federal taxes jointly would be eligible to pocket up to $500,000 of home sale gains, tax-free, provided they used the property as their principal residence for two of the prior five years.

Home sellers who file as a single taxpayer would be eligible to pocket up to $250,000 of gain tax-free. Sellers 55 or older who already had used their one-time $125,000 exclusion, and subsequently sold another house for a gain, could make use of the new provision as well.

For real estate investors, the House and Senate bills appeared to mix good news with bad. Republican majorities in both tax-writing committees rejected the administration's proposal to cut back on tax-free realty exchanges. In his budget package, President Clinton asked the Republicans to sharply narrow the definition of "like-kind" for the purposes of property swaps. Under long-standing tax law, the owner of a piece of income-earning or investment real estate can trade it for another piece of "like-kind" real property without federal recognition of taxable gain, even if the properties are dissimilar in use.

Under Clinton's proposal, tax-free exchanges could involve only properties that are "similar or related in service or use." But that proposal now appears to be dead, at least for inclusion in any 1997 tax bill.

Both the House and Senate bills would effectively deny full use of the proposed new 20 percent capital gains ceiling to owners of rental or business real estate. Both bills would impose higher tax rates on what's known as "recapture" of depreciation write-offs. The House bill would tax depreciation recapture at 26 percent; the Senate would tax it at 24 percent.

Say you bought a rental unit for $200,000 and sold it for $250,000. You made no capital improvements, and took $25,000 in depreciation deductions during your ownership.

Your taxable gain is $75,000 -- a $50,000 profit on the sale price, and $25,000 for the depreciation you wrote off. If current capital gains treatment were continued and the new 20 percent maximum rate applied to your entire gain, you'd owe $15,000 in federal taxes. Under the new approach contained in both bills, however, your gain would be split into two components -- depreciation recapture and increase in value -- and each would be taxed separately.

The Senate bill would apply a 20 percent capital gains rate to the $50,000 in resale gain, and a 24 percent rate to the $25,000 in depreciation. That would add up to $10,000 on the resale gain and $6,000 on the recapture. Your tax would be $1,000 more than you'd pay at a straight 20 percent rate.

The House bill would cost you slightly more. You'd pay $10,000 on your sales gain ($50,000 x .20), and $6,500 for recapture ($25,000 x .26). Although the change in the recapture rule seems modest in this example, it would have a far heavier impact on sellers who bought rental properties at the top of the market -- say sometime during the 1980s -- and now can't resell for what they originally paid. All their "gain" on the transaction is depreciation recapture. Rather than paying 20 percent, they'd end up paying about 25 percent, assuming the House and Senate split the difference between their rates in conference.

All these provisions are contained in massive bills that still have major hurdles ahead this summer. The two houses first have to put together a compromise package that attracts majority votes. Then comes the toughest hurdle of all: Clinton has to sign on.

Pub Date: 6/29/97

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