December 12, 1997

Big tax cuts coming to real estate

By TOM KELLY
The Real Estate Advisor

The National Association of Realtors is going to look back on 1997 as a very good year -- if not in sales then at least on the legislative side. Capital gains tax relief, clearly the biggest financial story in real estate this year, highlighted NAR's victories in the nation's capitol.

"We've worked years trying to get this thing done," said Stephen Driesler, the NAR's senior vice president of government affairs. "It finally came this year although it certainly did not happen over night. We feel it will benefit this industry for many years to come."

The question suddenly becomes just how long will this present tax law be in place? Can anyone realistically depend upon today's code when planning for retirement?

"I'm telling my clients that this benefit could go away with the stroke of a pen," said Conrad Gehrman, real estate tax specialist in the accounting firm of Arthur Andersen. "Anything could happen to change what is presently law. If there is enough pressure on Congress to repeal what's been put into place, things would change in a hurry."

The 1997 Taxpayer Relief Act signed into law in August will provide $91 billion in tax cuts over the next five years. For the first time in a decade, commercial and investment markets have been given tax benefit. The maximum capital gains tax rate has been reduced to 20 percent from 28 percent (10 percent in the 15 percent bracket) for sales on or after May 7, 1997. Real estate that can be depreciated -- for example rental homes, not your principal residence -- has been reduced from 28 percent to 25 percent.

The savings on that 3 percentage point spread alone (from 28 to 25) is expected to be $3 billion over five years. Won't this cash be sorely missed? And, when the impact is felt, won't lawmakers start pulling out their erasers and sharpening their pencils?

"You never know what another Congress will do or what another administration will support," Driesler said. "We do not anticipate, however, any immediate backlash to the new legislation."

The Taxpayer Relief Act also increases to $500,000 the amount of profit a home-owning couple can receive tax free on the sale of a principal residence, regardless of age. (Singles can exclude up to $250,000). This provision, effective for sales on or after May 7, 1997, replaces the rollover replacement rule" and the $125,000, one-time exclusion that were previously in place. Home owners can use the new exclusion at any age and as often as every two years.

What was not included in the tax package was part of House Resolution 9, the Jobs Creation and Wage Enhancement Act which provided for tax deductions for losses on the sale of a principal residence. A tax attorney on the staff of the House of Representatives' Ways and Means Committee said the proposal stemmed from complaints by homeowners in the Sun Belt and New England who said they were left with huge losses and no federal tax help when home values plunged during the past decade.

The problem wasn't very common until about 10 years ago because people just didn't sustain a lot of losses from home sales. But when the declining oil industry in Texas really shook the housing market around Houston, people began to question why they had to pay tax on any gain but got no help from a loss. New England had its share of declining values, too.

Analysts say that if a principal-residence loss were allowed, it would have been allowed only to offset a capital gain. If there is no capital gain, the loss would be prorated over time. For example, if you had a $20,000 loss on the sale of your home but had a capital gain the same year of $10,000, the loss would offset the $10,000 gain. Only a portion of the remaining $10,000 loss -- $3,000 -- would be allowed in one year. The $7,000 difference would be carried over to future years until fully used.

While NAR officials said they would not spend a lot of time chasing a deduction for losses on home sales, the organization plans to put considerable effort behind eliminating a tax on those losses. For example, let's say if you buy a home for $200,000 and take out a $180,000 mortgage. Years later, the market hits rock bottom and you try to sell the home for months. It finally sells for only $170,000, and, after commissions, the lender agrees to accept $165,000.

Not only would you be hit with a huge loss, but you could also face a tax on the difference between $180,000 and $165,000 ($15,000) because it is debt you did not have to pay or "relief of indebtedness."

Some areas of Puget Sound are not as torrid as some Seattle and Bellevue neighborhoods. If you mention multiple offers on the same house in Bremerton, veteran real estate agents and brokers will tell you it certainly is not the norm. In fact, folks who bought $180,000-$200,000 new homes two years ago are hard-pressed to get their cash out of the deal. Commissions and fees are eating away at equity and there's a glut of new homes on the market.

How about the awful feeling that would come from paying a tax on top of that?

Previous columns:

• Will better trained salespeople increase minority homeowners?, 12-05-1997
• Home loan rates will remain flat, 11-27-1997
• Boeing, CB-Bain sign affinity marketing deal, 11-21-1997
• Home-equity: Should you bet the roof?, 11-07-1997
• Builder sweetens Costco dealer for agents, 10-31-1997
• Should you increase your title insurance coverage?, 10-24-1997
• As interest rates dip, refinancing options abound, 10-10-1997
• Feds clean up Fair Credit Reporting Act, 10-03-1997