Tax Plans Could Help, Hurt Homeowners

Hidden away in the recesses of the Clinton administration’s massive fiscal 2001 budget proposal to Congress are several items that could prove helpful--or troublesome--to home buyers and owners around the country.

Although the proposals have drawn virtually no press attention, they could either put thousands of dollars into your pocket or cost you thousands, depending on your situation.

Tops on the list: a move to index to the rate of inflation the legal limit for escaping taxation on home sale capital gains.

Under federal tax legislation enacted in 1997, homeowners can exclude up to $250,000 (for singles) or $500,000 (for married joint filers) of capital gains on the sale of their principal residence. To qualify for the maximum exclusion, you need to have used the house as your principal residence for at least two out of the five years preceding the sale.

Though generous, the $250,000-$500,000 limits currently are frozen in the tax code. They do not adjust for inflation. And while inflation has been at nearly historic low levels in recent years, few economists expect that to continue indefinitely.

The president’s budget, incorporating a concept first outlined last year in a bill by Rep. Robert Andrews, D-N.J., asks Congress to tie the $250,000-$500,000 limits to the consumer price index.

Even with an index gain of just 3%, that amounts to noteworthy savings for single or married homeowners bumping the upper limits. A 3% inflation adjustment to the $500,000 ceiling adds $15,000 to the tax-free maximum, and $7,500 to the $250,000 ceiling.

More important, an annual inflation-adjustment system would offer homeowners the ongoing benefits of interest compounding. In a 3% inflationary environment, the tax-free limits would jump to $257,500 and $515,000 in tax year 2001.

Keeping Home Sales Tax-Free

If the inflation rate were to hit 3% again the following year, the increment would be multiplied against the higher base amounts of the previous year--a 3% increase on top of $257,500 would yield a new ceiling of $265,225 for singles, and a $530,450 limit for married joint-filers.

The net effect of inflation-indexing, argues the president, would be to keep as many Americans tax-free on home sales as possible. Without indexing, says the budget, “over time inflation could undermine the simplification benefits of (the 1997 law) by increasing many home prices above the exclusion limits.”

Another plum for home buyers in the Clinton budget: the first federal tax credit aimed at purchasers of “highly energy-efficient” new houses.

The credit would be a maximum $2,000 if you bought a home exceeding the standards prescribed by the International Energy Conservation Code of 1998. Among other things, the code sets targets for energy consumption in heating, cooling and hot-water components of homes.

If the house you purchase exceeds the energy code standard by 30%, you would qualify for a $1,000 tax credit. If it exceeded the standard by 50%, you’d qualify for the $2,000 credit.

Unlike deductions, the value of which are tied to your tax bracket, credits are subtracted from your bottom-line tax payment to the IRS. A $2,000 credit saves you $2,000 whether you itemize or not.

Not all the real estate provisions in the new budget would pad homeowners’ wallets, however. The president goes after a couple of loopholes, including the rarest of tax code boons--a long-standing provision that allows you to earn money tax-free.

The loophole allows any homeowner who rents a principal residence or second home for less than 15 days a year to pocket the rental income, with no tax liability whatsoever.

For instance, say you rent your house for a week for $4,000 to attendees at a major event--an industry, political or sport-related gathering--in your area. Under current law, you can pocket that $4,000 and not report it as income.

The Clinton budget would shut down that loophole: You’d have to pay taxes on all rental income received after Dec. 31, 2000, no matter the number of rental days.

Profiting From Tax-Free Exchanges

A final, more technical proposal in the budget that could cost a few taxpayers money: a restriction on the use of the $250,000-$500,000 capital gains exclusion in connection with homes acquired in tax-free exchanges.

Some creative real estate investors currently exchange their investment properties tax-free for a house. Then they treat it as a principal residence, and escape taxes when they sell it. The Clinton budget would force them to pay taxes if they sold the new house within five years of acquiring it via the tax-free exchange.

The prospects for all of this getting through the congressional meat grinder? Unknown at the moment. But many things--good and bad--move faster than usual in an election year.

Distributed by the Washington Post Writers Group.