Homeowners, Companies Will Be Moved by Capital Gains Cut

We may see a new American migration.

That’s what will happen when homeowners grasp the implications of the new up-to-$500,000 federal tax break for capital gains on residential real estate. The change, part of the recent budget and tax-cut deal, will allow homeowners to release equity tied up in a house and use it to:

* Leave an expensive, highly appreciated real estate area and move to a less expensive one, pocketing the difference;

* Scale down, tax-free, as part of a retirement plan, or take the income used to support one house and apply it to two less expensive houses. (Note that the break is $250,000 per spouse, so one person has less leeway.)

Instead of being called a budget bill, last month’s tax action could more appropriately be called the Tax-Free Migration Act of 1997. It will enable millions of long-term homeowners to make powerful rearrangements of their personal finances.

It will also make early retirement easier and will enter into the calculations of corporations considering a move. Over time, it may alter the real estate market--although real estate agents disagree on whether it will hurt values because of reduced demand for larger houses or help by making the real estate market more fluid.

The effect will be particularly strong for residents in high-cost, high-appreciation areas, such as California and the Northeast, although the prospect of paying hefty state capital gains taxes in those states may make at least some people hesitate.

Consider a few examples of how this may pan out:

* Big Corporate Moves. Years ago, when J.C. Penney decided to move its headquarters from New York to Dallas, Penney employees faced an interesting dilemma. If they sold their high-cost homes in New York, New Jersey or Connecticut and moved to Plano, Texas, they would be “forced” to move their gains into enormous and luxurious homes or pay major capital gains taxes.

If, for instance, a transferee sold a home in Montclair, N.J., for $300,000 and replaced it with a $200,000 home in Dallas, every dime of the $100,000 difference might be a realized capital gain that would have cost $28,000 in federal income taxes alone, plus several thousand more in state taxes. Many chose to buy houses beyond their wildest dreams instead.

Now consider the same scenario again. Moving from an area where houses are $200 to $300 a square foot to an area where they are $100 a foot presents a very pleasant choice: You can have a comparable house AND cash, you can have a lot more house, or you can have two houses. And all without a thought to taxes.

Watch corporate moves increase dramatically as firms realize that differences in regional housing prices are a powerful compensation tool, second only to stock options.

* Tax-Free Scale Downs. For decades we have been told to buy as much house as we could, and then buy more. As a result, millions of families own a lot more house than they need, particularly if they no longer have children at home.

The alternative for anyone under age 55 was to sell the big house and pay a substantial tax bill. If they were 55 and eligible for the old $125,000 capital gains exclusion, they faced a dilemma that was almost as bad: find every receipt for home improvements over the last 10, 15 or 20 years to keep the gain under the exclusion or at least minimize the amount over $125,000. And individuals who married after taking the exclusion prevented their spouses from taking full advantage of it.

Now, most scale-down moves will be free of taxes, age considerations and most record-keeping. And the gains are palpable. Suppose, for instance, an empty-nest couple has a $200,000 house owned free and clear that now costs about $12,000 a year in maintenance and taxes.

They can sell the house and buy a smaller one for $100,000. The new house might cost $6,000 a year to support, a dramatic savings of $6,000 after-tax dollars. That’s enough to persuade some people to retire a few years earlier.

In addition, they would add a net of $88,000 to their retirement nest egg. It was possible to do the same thing before the recent tax deal, but it was a lot more complicated and fraught with tax worry.

* Own Two Houses Instead of One. Until now, tax fears kept some couples from buying a second home. Now, it will be possible to sell a large house and reinvest the proceeds in two homes without paying a dime in taxes. Retirees could easily sell the old homestead and buy two vacation residences--or, for example, homes near each of their children.

Suppose you owned a $250,000 home with $150,000 in equity. Under the old tax law, a move to a $150,000 primary house would have incurred capital gains of up to $100,000.

Under the new law, you could sell the house and buy a smaller one for $150,000. You could finance that home for $100,000, just like your former house. The transaction would be tax-free. Then you could pay cash for a $100,000 second home. The total cost of owning both homes would be about the same as owning a single one. Since one of the homes could be used for vacations that you would otherwise spend at hotels, it could actually be more economical.

Basically, Congress has given us a free hand with housing choices.

* TAX IMPLICATIONS

Filing will be more complicated, analysts say. A1