DON'T BE MISLED by all the backslapping and bipartisan mirth on Capitol Hill about capital gains cuts and a balanced budget deal.
If you've owned any form of investment real estate -- a rental condo at the beach, a duplex downtown, a small apartment building -- the tax-cut outlook is more somber than you may think.
You need to know about a little publicized $5 billion to $10 billion revenue-raising plan under serious consideration by congressional tax writers that could render a capital gains reduction virtually meaningless for you.
Call it congressional tax discrimination against real estate owners. It's not included in any official budget documents or tax-committee summaries. Congressional staff experts won't even talk about it on the record. But privately they confirm that it is an active option. Here's how it would work.
House Ways and Means Committee Chairman Rep. Bill Archer and other Republicans are determined to cut the federal capital gains levy to 19.8 percent this year as part of the balanced budget deal with the Clinton administration.
But Capitol Hill sources say Republican tax writers are actively exploring a concept that would deny full use of the 19.8 percent rate to many rental and business real estate owners.
The plan would allow the new, low rate to be used only on those gains on a sale that represent an actual increase in the price or market value of the property since the seller acquired it.
The current 28 percent capital gains rate -- not the new, lower rate -- would be imposed on all realty investment gains attributable to depreciation deductions taken by the sellers during their time of ownership.
In effect, real estate owners would become second-class citizens under the federal tax code. Whereas sellers of stocks and bonds would be taxed on their gains solely at the 19.8 percent rate, real estate sellers would be hit with two rates -- 19.8 percent and 28 percent.
The rule would affect most small-scale rental property owners, but would be particularly tough on longtime owners.
Here's a simplified example. Say you bought a rental property for $100,000, made no capital improvements, took $25,000 in depreciation deductions, and sold it for $125,000. Your taxable gain is $50,000 -- $25,000 on the sale, and $25,000 in depreciation, which lowers your tax "basis" in the property and is recaptured at the prevailing capital gains rate.
Under the proposed plan, you'd pay a 28 percent rate on the $25,000 depreciation recapture ($7,000), and 19.8 percent on the $25,000 resale profit ($4,950). The total tax would be $11,950, which works out be an effective "blended" rate of about 24 percent.
By contrast, if you bought corporate stock and sold it for a $50,000 profit, you'd be taxed solely at the 19.8 percent rate. You'd pay $9,900 to the government in capital gains.
Why are congressional tax writers so interested in a plan that would treat one category of capital asset -- real estate -- differently from all others? The key reason, say Capitol Hill staff members: It would raise big bucks for the Treasury, and help pay for a big chunk of the $30 billion-plus estimated cost of a broad-based capital gains cut.
Estimates of the added revenues range from $5 billion to $10 billion over five years. The theory, say tax analysts, is that any lower capital gains rate would entice real estate owners to sell -- even if the effective rate they paid wasn't as low as what's paid by stock sellers.
But for large numbers of rental property owners -- especially in large urban markets -- the plan could represent no enticement whatsoever. For many small-scale rental home and business property owners who bought during the last 10 to 15 years, there's been relatively little increase in market values from when they first purchased.
The National Realty Committee, a trade group, estimates that three out of every five investment or business properties acquired in 1986 now sell for below their original cost.
Every seller -- or would-be seller -- of such below-original-cost real estate now faces a taxable gain on a sale because of depreciation recapture at 28 percent.
Capital gains "reform" of the type being considered on Capitol Hill would provide them no incentive to sell under the blended-rate proposal. They'd continue to sit on heavily depreciated rental buildings that need renovations that only new buyers could afford to pay for.
The outlook? The proposal is certain to provoke a fight when the tax committees begin writing their bills in June. Twenty Ways and Means committee Republicans already have asked Archer to drop active consideration of the plan. So far, he's been mum.
Kenneth R. Harney is a syndicated columnist. Send letters care of the Washington Post Writers Group, 1150 15th St. N.W., Washington, D.C. 20071.
Pub Date: 5/25/97