The ink is barely dry on the 1997 tax law, but creative accountants and tax lawyers already have spotted ways for homeowners -- and other real estate owners -- to reap benefits beyond what even Congress might have contemplated.
Tops on the list: Call it the serial home-sale strategy.
It could save some property owners hundreds of thousands of dollars over a period of years.
The technique has potential applicability to homeowners who also own a second house or condo, a vacation house or any rental residential property.
But anyone can use it.
Greg Jenner, a former Senate Finance Committee staff member who is now national director of tax policy for the accounting firm ++ of Coopers & Lybrand, discussed the concept in an interview the other day.
Now that homeowners who sell their principal residence can escape taxation on up to $500,000 of capital gains (if married and
The answer, according to Jenner: Once you sell your current home with zero federal taxes on your profits, you move into any second (or additional) residential property you own and convert that property into your principal residence.
Under the new tax law, you
Although Jenner says he originally assumed that the concept would have prime value "to Daddy Warbucks types who own several houses," he agrees that it would work for vacation homeowners or small rental-home investors as well.
The only hitch for rental-property owners, Jenner added, is that they'll have to comply with the new depreciation "recapture" rules in the 1997 tax law, exposing them to a 25 percent tax liability on a portion of their gains when they sell.
Here's how the serial sale
Say you're a homeowner and you've had outstanding luck with your real estate -- chalking up big jumps in the resale values of your principal residence and your beach house.
Under the revised federal tax law, the gains on your principal home qualify for the $500,000 tax-free treatment, but not the gains on your beach house.
Assuming you've never rented out the beach house or treated it as an investment property, the gain if you sold it today would be exposed to taxation at the new 20 percent capital gains rate.
How to reduce that exposure to zero?
Convert the beach house to your principal residence for two years -- if that's feasible for you -- and then sell.
To avoid problems with the Internal Revenue Service, make sure that your move is bona fide. That is, be certain that you do all the things the IRS looks for in audits to establish your true principal residence -- e.g., you change your voting registration to the new house, you switch your auto registration to the new address, and you really live there.
In short, you don't play games with Uncle Sam.
Here's a second example, this time oriented to the homeowner who also owns a rental property.
The concept works the same as it would with a nonrental second home.
You convert the rental home to your principal residence, taking over your existing tax "basis" -- or cost for tax purposes -- as your measuring point for computing gains.
For instance, if you bought a house for $75,000, made no improvements to it but took $15,000 in depreciation deductions during your ownership, you'd convert the property to your principal residence with a tax "basis" of $60,000 ($75,000 minus $15,000).
Two years after converting it to your principal residence, you sell the home for $225,000.
That's a $165,000 gain, given your $60,000 basis.
Under the 1997 tax law, you'd have to slice your capital gain into two parts -- the gain attributable to the depreciation you pocketed and the gain attributable to the home's increase in resale value.
The $15,000 depreciation you took gets taxed at 25 percent ($3,750).
The rest of your gain -- $150,000 -- qualifies as profit from the sale of a principal residence and escapes taxation altogether.
So, instead of paying 28 percent in federal taxes on your $165,000 gain, as you would have prior to the 1997 tax law -- a painful $46,200 -- you pay just $3,750.
And, if you happen to own another property that's increased in value -- and your lifestyle can accommodate the change -- you can convert it into your residence and begin the tax-saving process all over again.
Pub Date: 8/24/97