Update on Capital Gains Reforms for Home Sellers

Tantalized by the prospect of pocketing tax-free cash, large numbers of homeowners have begun peppering congressional and real estate trade-group tax experts with questions about how to make use of the Clinton administration’s proposed capital gains reforms for home sellers.

The Clinton plan would allow married individuals who file joint tax returns to pocket up to $500,000 of gain from the sale of a principal residence. Unmarried taxpayers, or married persons filing separately, could take up to $250,000 of profits tax-free.

To answer some of the most frequent questions about the proposal and where it stands on Capitol Hill, here’s a quick overview:

* When would the plan take effect? Assuming it’s passed by Congress later this year in its current form, the proposal would cover all qualified home-sale transactions occurring on or after Jan. 1, 1997.

It would also allow taxpayers who sell a home after Jan. 1 but before the date of enactment of the legislation to choose between the current, long-standing rules regarding home-sale capital gains and the new law. For sales after the enactment date, you’d have to use the new rules.

* Is it safe to bank on the Jan. 1, 1997, date? Can you be certain that if you list and sell your home this spring, the new, generous tax treatment will apply? Anyone familiar with the legislative process will tell you bluntly: Never bank on Congress doing anything you expect or want it to do.

President Clinton’s proposal at this stage is just that. It’s not law. And penny-pinching tax-writers frequently manipulate effective dates to lessen revenue losses.

However, there’s a better-than-even chance that if Congress does pass the president’s proposal, the Jan. 1, 1997, date will be the effective date. Two reasons: First, both Clinton and his Republican presidential opponent, Bob Dole, called for a Jan. 1, 1997, effective date in their tax proposals. Second, the amount of revenue that could be saved by moving to a later date would not be substantial, say congressional tax experts.

“With so many [homeowners] already believing Jan. 1 is the magic date,” said one staffer recently, “it may not be worth the political flak to move it.”

* How might older home sellers be affected? Would the new legislation affect seniors 55 years and older who planned to use the current $125,000 tax-free capital gains exclusion? Should seniors delay sales to take advantage of the new law?

The Clinton proposal would terminate the current tax-free exclusion for senior home sellers. Seniors who close on home sales between Jan. 1, 1997, and the date of enactment could still use the $125,000 rules if they wish. But most seniors with large capital gains undoubtedly would prefer the new, simplified rules in the Clinton plan.

Besides the advantage of a much higher tax-free exclusion threshold--$500,000 instead of $125,000--the Clinton plan would eliminate all the technical hassles associated with the current once-per-lifetime rules. Seniors with gains over $125,000 who want to be absolutely safe about maximizing their tax savings should delay closing their sales transactions until Congress passes the Clinton proposals.

* What about seniors who have already used their $125,000 exclusion? Would they be allowed to use the new capital gains plan for future sales? The president’s budget submission to Congress did not address this issue. It is possible, however, that when the proposal is drafted in legislative form, some limitation on taxpayers’ use of both the $125,000 and the new, higher exclusion amount within a two-year period could be imposed.

* How long must you have lived in your home prior to sale? You have to own and occupy your house as a principal residence for at least two years out of the five years prior to the sale. If you sell one house tax-free and then buy another and live in it for two years or more, any capital gain on the second sale up to the $250,000-$500,000 ceiling could also qualify for tax-free treatment.

* Would other capital-gains reforms affect the proposal? How would the tax-free home-sale concept interact with the sort of broad-scale capital gains tax reforms now being pushed on Capitol Hill by the Republicans? Think of it as icing on your cake.

If you’ve got a home-sale gain in excess of the $250,000 or $500,000 cap that applies to you, you’d pay a lower tax on the excess if Congress cuts the current 28% capital gains rate. The Republicans want a 19.8% top rate on gains from all capital assets, including real estate. That means that if you were a single taxpayer with a $400,000 home-sale gain, for example, you’d pocket the first $250,000 tax-free and pay 19.8% on the $150,000 excess. Instead of a federal tax bill of $42,000, you’d pay $29,700.

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Distributed by the Washington Post Writers Group.