house isn't just the place where you kick off your shoes at the end of the day; it's an investment. Now, thanks to the Taxpayer Relief Act of 1997, your home is a sweeter investment than ever, because you'll likely never have to pay a penny of federal capital gains tax when you sell it.
A capital gain or loss on real estate is the difference between a home's selling price and its basis, or cost. For example, a house that cost $30,000 in 1968 and sells for $130,000 in 1998 nets a $100,000 capital gain.
At the heart of the act's rules pertaining to real estate is a $250,000 exclusion for individual tax filers ($500,000 for joint filers) of profit from houses sold on or after May 7, 1997. With the average house selling at about $125,000, most sellers never will owe capital gains tax. And, any nonexempt gain will be taxed at a much lower rate than under the old law.
| Most house sellers
never will owe
a penny of capital
can trade down
|More gain, less pain
Before President Clinton signed the act last year, home sellers avoided paying Uncle Sam a portion of their gain in one of two ways: They could roll over the entire profit from the sale of their old house into a new one of equal or greater value within two years, or they could take advantage of a one-time $125,000 exemption if they were 55 years or older.
The rollover rule meant that people often ended up purchasing or building more house than they actually needed so they could defer taxes from the sale of their old house. Thus, the new law gives sellers greater freedom to trade down for a less expensive house, or even to rent rather than buy.
While the new law also eliminates the one-time tax exemption for seniors, it extends a greater exclusion to all taxpayers. And it's no longer just a one-time deal. To qualify for the maximum exclusion, the house must have been the seller's principal residence for at least two of the five years before the sale.
Hypothetically, a couple could sell a house every two years and pocket whatever they gain up to $500,000. For those who enjoy renovating old homes and selling every few years, this more-flexible rule is a real boon.
Another benefit: Homeowners who won't owe capital gains tax when they sell no longer must maintain detailed records of capital improvements, such as room additions or renovations, to substantiate their home's real cost.
Why the government's generous tax cut? According to the act's supporters, the less tax on capital gains, the more money consumers have to reinvest in the economy. Sellers who decide to purchase a less-expensive house could put the equity they earn from their old home into a college savings plan, invest in the stock market, capitalize a small business, or purchase a vacation cottage. Or they could use the cash as the down payment on a pricier home.
|Rates and rules
Any profit exceeding the exclusion limit now is taxed at a 20% rate. For taxpayers in the 15% income tax bracket, the rate is 10%. Under the old tax law, taxpayers above the 15% bracket paid a 28% capital gains rate; those in the 15% bracket paid 15%.
Say a widow sells a house that cost $180,000 when purchased 20 years ago. In 1998, the home fetches $500,000. Her net profit, or capital gain, is $320,000. The tax-exempt portion is $250,000, which leaves $70,000 in taxable profit. At the 20% rate, she'd owe the government $14,000 (at the old 28% rate, she'd owe $19,600). Here's the math:
|- $180,000||Basis (cost)|
|-$250,000||Tax exclusion for single filer|
|$ 70,000||Taxable gain|
|× .20||Tax rate|
|$ 14,000||Federal taxes due|
|Anyone who sold a principal residence in 1996 between Jan. 1 and May 7 must calculate capital gains tax according to the rules in effect before the 1997 act. Property sold on or after July 28 is taxed according to the old rate if it was held for more than 12 months but fewer than 18 months.
If a job transfer or other circumstance forces a homeowner to sell before having lived in a house for two years, the tax exclusion is prorated based on the percentage of the two years during which the home was the seller's primary residence.
A second home or other nonprimary residence does not qualify for the tax exclusion.
For some sellers there are down sides to the new law. As before, capital losses still are not deductible. And people with homes that have appreciated substantially above the exclusion limit no longer can shelter their capital gains by purchasing more-expensive homes.
For most people, however, the new capital gains law offers greater flexibility to choose their next home and far fewer hassles at tax time.
|Capital Gains Tax for Real Estate
(effective May 7, 1997)
|Filing status||Capital gains
tax rate (nonexempt)
|Married filing jointly||$500,000; must be principal residence for two out of past five years||20%; 10% for taxpayers in 15% bracket*|
|Single||$250,000; same rules apply as for joint filers||Same as above|
|* 15% tax rate bracket: Married filing jointly with income = $0-$42,350; single income = $0-$25,350. In 2001, the capital gains rate for sellers who've lived in a house for more than five years drops to 18% if they're above the 15% bracket and 8% if they're in the 15% bracket.|
|©1998 Credit Union National Association, Inc.|