Homeowners to profit from new tax rules Congress blunts taxman's horns

Nation's Housing

July 19, 1998|By Kenneth R. Harney

CALL IT the ultimate layer of icing on the homeownership benefits cake. Thanks to legislation passed last week by Congress, not only will most homeowners be free of federal taxes whenever they sell their property at a profit, but they'll also be less likely to have their home seized by the IRS in the event they get into a dispute over back taxes.

The massive Internal Revenue Service Restructuring and Reform Act sent to President Clinton for signature contains loads of goodies for taxpayers in general, but has three special provisions aimed solely at homeowners. Two of them -- barely publicized -- are intended to protect your house if you get into a spat with the tax collectors.

Under the new rules, the IRS no longer can seize your personal residence to obtain back taxes when the amount you owe, including penalties and interest, is $5,000 or less.

The legislation also requires the IRS to exhaust all other administrative remedies and alternative payment options before it seizes a personal residence, no matter how much the back taxes due.

The reforms are intended to counter taxpayer criticisms that in the past the IRS used home seizures and levies too frequently and capriciously to satisfy even small unpaid tax liabilities. Under the new law, not only your principal home but other nonrental vTC real property you own that someone else is using as a home -- for example, a "granny home" occupied by a relative rent-free -- will gain new protections against seizure in the event of a payment dispute with tax collectors.

The other big change under the new legislation concerns home sale capital gains, and effectively completes the move toward tax-free home profits begun in last year's Taxpayer Relief Act.

Under the sweeping 1997 reforms, individual home sellers are allowed to retain up to $250,000 of profits ($500,000 for couples) on sales of homes they've used as a principal residence for two of the prior five years. For the vast majority of home sellers, this means zero federal taxes whenever they close on the sale of their house. Even better, they can escape federal taxes on every residence they sell every two years.

But for people who own and occupy their houses for less than the required two years, the 1997 law was a little murky.

It said such sellers could take a pro-rata capital gain exclusion on profits based on the amount of time the property was actually used as a principal residence. Left unclear was just how to apply the pro-rata test in real-life tax situations. For example, if you're a single executive in San Francisco, you bought a house 12 months ago and now you're being transferred to New York, how do you handle the $150,000 net profit you racked up in that rapidly appreciating market?

Do you apply your residence-period fraction -- one year is one-half the required two years for maximum exclusion of gain -- to your $150,000 profit? That would mean $75,000 of your gain goes tax-free, and $75,000 gets hit with capital gains tax.

Or do you apply it to the statutory maximum of $250,000 for single tax filing? If the latter, you could pocket $125,000 (one-half of $250,000), and pay tax only on the $25,000 remainder.

Through a drafting oversight, the 1997 law never explicitly answered this question. So some accountants advised clients to play it safe, and assume that Congress intended the residence-period fraction to apply to your actual dollar gain, not the statutory maximum gain.

In the legislation passed last week, Congress corrected last year's oversight. You apply your residenceperiod fraction to the statutory limit, not to your gain.

So how does that shake out for most short-term homeowners who sell because of a job transfer or for health reasons? Pretty nicely, especially if you're lucky enough to own and sell in a high-inflation market, but your gain doesn't exceed the statutory limit.

Here are just a couple of illustrations of how the law works. Technically, the fractions should be expressed in days, not months: You own for 16 months, you're married and file jointly, and your gain on a luxury home comes to $300,000. Multiply two-thirds (16 months of 24 months) times the $500,000 statutory ceiling, and your maximum allowable tax-free exclusion comes to $333,333. You pay nothing to the feds.

You own a home for just eight months before your employer transfers you. You're single and you net a $100,000 profit on the sale of the home. Your residence-period fraction is one-third (8 months of 24). That means that $83,333 of your gain can be excluded, and $16,667 is subject to taxes.

Not bad at all for just eight months of homeownership. Get the message Congress is trying to send you?

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: 7/19/98

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