Carol Lollich, Broker-Owner
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The Tax Reform Act of 1997 was very beneficial to almost all owners of real estate. It includes good news for homeowners and first-time buyers. It also includes a little bad news, too. We thought it would be helpful if we summarized the impact it will have on homeowners.
Among other things, the new law cuts capital gains tax rates for many investments, and provides gains relief for homeowners who sell their homes at a profit.
The act provides a $250,000 capital gains tax exclusion for single taxpayers and a $500,000 exclusion for married taxpayers for the sale of a home where the owner(s) has resided at least two of the last five years. The law is applicable to transactions which take place after May 6, 1997, and replaces the former "rollover of gains" provision as well as the one-time $125,000 exclusion for those aged 55 and over.
Federal capital gains tax rates will be generally lowered from the current rate of 28% to 20% for those in upper income brackets, and from 15% to 10% for those in lower brackets (California rates are not affected). These rates will be lowered even further in 2001, to 18% and 8% respectively, for assets held five years or more. It appears that gains due to depreciation will be taxed at 25%, while the difference between the purchase price and the selling price will enjoy the lower overall capital gains tax rates.
The law also allows for limited, penalty-free withdrawals from Individual Retirement Accounts (IRA's) for first time home buyers. It is believed that taxpayers will be allowed to place up to $2,000 in savings into a new IRA account for this purpose each year, and qualify for deferring taxes on those savings.
The new law does not grant a deduction for losses on the sale of personal residences. (Debt reduction or "forgiveness" due to relief granted by a lender in a short payoff situation is considered ordinary income, and not subject to capital gains treatment.)
The timing of a sale, and the length of time an asset has been held are very important elements of the new law. As well, some homeowners will now have to pay taxes that otherwise would have been deferred, due to the elimination of the rollover provision.
Overall, homeowners with long term gains up to $250,000 (singles) and $500,000 (couples), who have waited to scale down into a smaller home will benefit from the law. Homeowners who have gains in excess of the above thresholds, and who have customarily "rolled over" those gains into a home of equal or greater value will now find that they must pay gains taxes on any profits in excess of the threshold amounts, even if they purchase a more expensive home than the one they sold.
Here's the disclaimer. Because of the complexities involved in the new law, the information contained herein is not to be relied on. We strongly urge you to consult your tax specialist concerning your ability to take advantage of the new lower rates when selling a personal residence, the new IRA account provisions, and all other aspects of the law.