Capital gains plan bad for depreciation

Nation's Housing

March 31, 1996|By Kenneth R. Harney

WASHINGTON -- If you own any type of investment real estate -- a small rental condo, a place at the beach, an apartment building -- you could be directly affected by a controversial capital-gains tax proposal under discussion here by congressional and Clinton administration budget balancers.

Sources close to the budget negotiations confirm that to raise revenue while cutting overall capital gains taxes, negotiators have seriously considered eliminating a key, traditional benefit enjoyed by real estate owners.

The change is considered enticing because it would raise substantial dollars for the Treasury -- possibly $7 billion to $8 billion in tax revenues over a seven-year period. Though neither Republicans nor the Clinton administration claims authorship, Capitol Hill staff members say the plan could emerge as an element in a compromise budget package.

The proposal has to do with depreciation deductions. Under current law, all your gain on the sale of a piece of investment real estate is taxed at one capital gains rate -- 28 percent. The write-offs you've taken for depreciation on the property during the course of your ownership get included in the calculation of your gain. In effect, these write-offs are "recaptured" for tax purposes, but at the capital gains rate, not your income tax rate, which may be higher.

The plan discussed by negotiators would change this significantly: Any profits from the sale you rack up on your property beyond its original cost would be taxable at a new maximum capital gains rate of 19.8 percent. Depreciation write-offs recaptured at sale would be taxed at 28 percent. Though the recapture rate might be less than your ordinary marginal income tax rate, it would depart from real estate tax tradition: It would be higher than the new capital gains rate. What had been treated favorably as capital gains -- your depreciation write-offs -- would now be taxed higher.

To see what that might mean, consider this example. Say you bought a modest rental house years ago for $100,000. Using straight-line depreciation, you've written off $50,000 on the house. You go to sell it in 1996 and find that because of depressed market demand for this type of house, you can't sell it for anything more than you paid for it -- $100,000.

Since you took depreciation on the house, you lowered your tax "basis" or cost in the property by that amount -- $50,000. You owe Uncle Sam taxes for that, but at what rate? Under the balanced-budget plan passed by the Republican-controlled Congress but vetoed by President Clinton last year, the maximum capital gains tax would have been 19.8 percent. That's the most you'd pay on your recaptured $50,000 in depreciation write-offs -- $9,900. Under the proposed system, by contrast, you'd be taxed at 28 percent on the $50,000 -- $14,000. That would represent a 41.4 percent higher tax than you'd pay under a 19.8 percent top rate.

With many investment properties now valued below their original cost in the 1980s, according to the National Realty Committee, the proposal would offer no help to the thousands of property owners who face potentially staggering tax bills -- due to prior depreciation write-offs -- even if they sell at a loss.

Pub Date: 3/31/96

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