ROBERT L. SOMMERS
Note: This exercise is for educational purposes only and is not intended to be legal or tax advice. Your particular facts and circumstances must be considered when applying the U.S. tax law. You should always consult with a competent tax professional with respect to your particular situation.
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Clinton's current proposal for sales of principal
residences (now winding its way through Congress without
serious opposition) will exclude the first $500,000 of
gain from taxation. This sounds great for those
Californians who want to downsize (move less expensive
home without incurring any tax). Californians could sell
their homes, exclude $500,000 of gain and happily retire
in the great Northwest.
Unfortunately, those large capital gains might get the
shaft. The proposal will eliminate two key provisions in
the current law: (1) the current rollover provision which
eliminated any capital gain if, in general, you acquired
a replacement residence of equal or greater value, within
24 months from the sale of your old residence; and (2)
the once-in-a-lifetime election for those age 55 or older
which permits you to exclude up to $125,000 of gain on
Under current law, you could exercise your
once-in-a-lifetime election to exclude $100,000 of your
gain and use the rollover provisions to purchase a
replacement home at no tax cost. Under Clinton's
proposal, you'll have a $1M gain minus a $500,000
exclusion and, consequently, a capital gain of $500,000.
Using a combined federal and California tax rate of 33%,
your income tax liability will now be $167,000.
This tax proposal could be devastating for those with
large potential capital gains who plan to acquire a
similarly priced home for retirement. In your case,
you'll have $933,000 after the tax is paid ($1.1 million
sales price less $167,000 in taxes) -- not enough to
purchase the $1 million replacement home. Of course, this
new law will adversely affect your ability to sell your
house, since buyers cannot use the rollover provisions to
acquire it (although they can use the $500,000 exclusion)
and will probably impact the seller of your new
replacement home, because you'll have less money to
purchase it. The added tax cost should cause a price
decline in the market for expensive homes, thereby
harming major segments of the real estate industry.
Another hidden cost in this proposal is the effect on
property taxes under Proposition 13. If housing values in
wealthy communities drop in proportion to the new tax
cost (assume roughly 15-25%), then recent home purchasers
will have a strong argument for a downward adjustment on
their property taxes, since the value of their homes
would have suddenly decreased.
The Clinton proposal would be fairer if taxpayers
could choose either the new $500,000 exclusion or current
recent success in the workplace has triggered the
"passive activity loss" limitations for owners
of real estate. Under current law, those who
"actively participate" (making management
decisions such as the amount of lease rent or arranging
for upkeep) in real estate may deduct up to $25,000 in
annual losses against their income. Unfortunately, once a
person's adjusted gross income (AGI) reaches $150,000,
then none of the losses are currently deductible. The
$25,000 deduction is phased out at the rate of $1 for
every $2 of AGI over $100,000. For instance, if your AGI
is $130,000, then you are entitled to $10,000 of losses
($30,000 of additional AGI reduces your $25,000 deduction
Suspended losses are carried forward and are used to off-set additional income from the property or may be reinstated if the taxpayer's AGI falls below the $150,000 ceiling. Generally, once there is a disposition of the entire activity, such as a sale of the only rental property you own, then the suspended losses may be used in full. With multiple properties, certain elections must be made with respect to the disposition of the entire passive activity. The passive activity loss rules are enormously complicated and expert advice is necessary for those who own multiple properties or who have partial interests in property through partnerships, corporations or limited liability companies.
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**NOTE: The information contained at this site is for educational purposes only and is not intended for any particular person or circumstance. A competent tax professional should always be consulted before utilizing any of the information contained at this site.**