IT'S NOT an issue that evokes much sympathy from fellow taxpayers, but it's a growing problem nonetheless: unprecedented home equity appreciation during the past decade has pushed a rapidly swelling number of homeowners beyond Congress' $250,000 and $500,000 tax-free limits on real estate gains.
Boohoo, you say? That's understandable if you're nowhere near bumping into those limits or you're tired of hearing about billowing federal budget deficits. But new research from Harvard University and reports from the front lines by prominent tax lawyers and financial advisers suggest that the current congressional capital gains ceilings are being outrun by real estate inflation.
The research from Harvard's Joint Center for Housing Studies found that as many as 850,000 American homes might be valued at $1 million or more. Far more are valued at $500,000 or more. Most of these homes are in areas with sustained high appreciation since the mid-1990s, frequently in the double digits per year.
As a result, in some cities million-dollar homes represent significant percentages of the total housing stock. In Harvard's hometown of Cambridge, Mass., for example, one out of every nine homes is worth $1 million or more.
San Francisco, the District of Columbia, Los Angeles, Boston, New York, and Fort Lauderdale, Fla., all have large numbers of million-plus houses. And one state - California - boasts sprawling geographic swaths where a $500,000 home not only is unremarkable, but below average. In California's highest-cost communities, $1 million is the entry-level cost for a fixer-upper or a tear-down.
Such widespread high prices, plus 200 percent to 400 percent underlying equity gains for many owners, were nowhere in sight when Congress streamlined the home real estate taxation rules in 1997. A key purpose of the reforms, said Capitol Hill proponents at the time, was to eliminate federal taxes for virtually all home sales except those of the super-rich.
Yet today, even middle-income, longtime homeowners in large areas of the country find their gains far outstripping the $250,000 (single filer) and $500,000 (married joint filer) tax-free exclusion limits.
Gerald J. Robinson, a New York real estate tax lawyer, says that "it's really a very commonplace problem. People who never thought they could possibly [exceed the limits] now find themselves owing money" to the Internal Revenue Service when they sell their homes.
Robinson has written a new book, J.K. Lasser's Homeowner's Tax Breaks (Wiley, 2004), that includes a chapter on how owners can reduce or avoid capital gains taxes.
For starters, Robinson notes that far more taxpayers are probably over the limit than realize it, especially baby boomers and others who have owned and sold a succession of houses during the past 20 to 30 years.
Robinson points to a couple in their early 60s who first purchased a home in 1967 for $45,000, resold it for $100,000 in 1972 and purchased a $105,000 replacement home. The couple deferred the $55,000 gain under the old "rollover" tax rules.
Five years later the couple sold the 1972 house for $195,000, rolling over their gain tax-free by purchasing a $200,000 home. The couple moved and resold three more times over the succeeding years, eventually buying a $950,000 home in 1996.
Between 1972 and 1996, the couple deferred tax recognition on a stunning $850,000 in gains. If they now sold the $950,000 house for $1.1 million - not an exceptional event, as the Harvard study documents - the couple faces what Robinson calls a "tax time bomb."
With an adjusted tax basis of just $125,000 - stretching back to their original $45,000 basis in their first home purchase - the couple now confronts a $975,000 cumulative gain. That is the sum of the gain on the sale of the current home ($150,000) plus their prior, rolled over gains of $825,000 dating back to 1972. The capital gains tax bill, even using the full $500,000 exclusion: $71,250.
Couples like this can cut their taxes by retaining detailed records of the capital improvements they made on any of their houses to offset their gains. They also can consider some other strategies, according to Robinson, including never selling again.
Ken Harney's e-mail address is email@example.com.