CREATIVE homeowners and small-scale real estate investors are coming up with new money-saving twists on Congress' 1997 changes to the Internal Revenue Code.
Among the most ingenious, according to accountants and lawyers, are those that maximize the benefits of the most generous real estate change in last year's law -- the $250,000 (for single filers) and $500,000 (joint filers) capital-gains exclusions for home-sale profits. Even more clever are concepts that meld the new exclusions with tax-deferred real estate exchanges under Section 1031 of the code.
Here's a sample of the ideas property owners and their advisers already are using:
* Tax-free retirement planning with the help of an exchange. Say you and your spouse own not only your home, but also a rental house that's built up a sizable taxable gain because of appreciation and your depreciation write-offs. With the help of a professional exchange "intermediary," you can swap your rental home for a house in a resort location to which you might enjoy moving as you head toward retirement. You rent out this "replacement" property to tenants. Via the exchange, you escape federal taxation on the gains you've built up in your original rental house. Your tax cost or "basis" in that property moves to your new rental.
A few years later, when you're ready to make your retirement move, you sell your principal residence (pocketing up to $500,000 in gain tax-free) and move into your replacement rental house at the resort, converting it to your principal residence. Once you live in that residence for two years or more, your taxable gain from what had been rental investment real estate turns into gain on a principal residence, and is subject to the new $250,000/$500,000 exclusions.
Your combined tax-free profits from the capital-gains exclusion on your first home and the deft use of Section 1031 to acquire a second -- assuming that you did the exchange with competent professional guidance -- could total as much as $1 million.
* Slice-and-dice to save taxes. San Francisco lawyer and intermediary Michael K. Phillips says he sees many situations where property owners can save big dollars by simply dividing their real estate into its functional pieces.
One client found that the taxable gain on her 35-acre home and country acreage would exceed the new $500,000 exclusion cap. The solution: Treat the property as having two constituent parts. The home itself sits on a 5-acre parcel that's long been fenced off from the other 30 acres, which are rented out to graze cows.
