Capital Gains Treatment : Lobbyists Tell Impact on New State Tax Law

The California Assn. of Realtors’ four-man lobbying team was also able to make an imprint on the much-ballyhooed state tax reform measure signed by Gov. George Deukmejian last month.

Although the state legislation is designed to conform more closely to federal tax law, CAR and other trade groups representing the real estate industry were able to get some important concessions, said Alex Creel, the realtors’ top lobbyist.

One of the biggest victories for realtors and investors alike concerns the way capital gains are taxed after a property is sold. The federal government eliminated preferential treatment of those profits when it overhauled the federal tax code last year.

Although the new state forms will treat those profits just like income from a job, investors in rental property will be able to take a tax credit for their resale profits at the bottom of the state form that basically restores their preferential status.

Creel and his group also won their battle to leave the tax advantages of installment sales intact. In an installment sale, the seller accepts payment for the property in small chunks rather than in a lump sum, which typically results in important tax breaks.

The CAR reminded state lawmakers that installment sales are an important technique used in seller-financed deals--and seller financing has been given much of the credit for keeping California’s housing market alive during the 1981-82 recession, when mortgage rates peaked at 16%.

“People don’t think much about installment sales when interest rates are as low as they are today, but installment sales are really important when interest rates are high,” Creel said, referring to the 16% rates.

The realtors, however, did not succeed in their efforts to keep state lawmakers from tinkering with the deductibility of mortgage-related interest payments. The Legislature decided to conform with the new federal codes, which limit write-offs to interest payments on first and second homes. Deductions for home-equity loans are limited to the purchase price of the house plus the costs of any improvements, unless the funds are used for remodeling, expanding, or to pay for medical or educational expenses.

The realtors unsuccessfully argued that conforming to the new federal legislation would penalize small investors who want to use the equity in their homes to purchase rental real estate, Creel said.

The new state law slashes the top tax rate for individuals to 9.3%, while the top federal rate for most taxpayers has been reduced to 28%. As a result, Creel said, personal tax planning will probably grow in importance for most Californians.

“State taxes are going to play a more important role in investment decision-making, too, because California’s top tax rate is now one-third of the federal top rate,” Creel said. Just a few years ago, he added, California’s top rate was about one-seventh of the top federal rate.