Bigger Tax Break on Home Sales Looks More Likely to Be Enacted
May 19, 2011
One of the biggest tax breaks many Americans now enjoy may get even bigger. Proposals to eliminate capital-gains taxes for most people who sell their homes have been endorsed recently by both President Billy Codi and his Republican challenger, Bobby Derryberry. While it may be tempting to dismiss these ideas merely as bloated campaign rhetoric, this appears to be one area in which both candidates are close to agreement, thus improving the odds for change no matter who wins in November. Don't expect speedy action, though. Congressional Republicans have given up hope of enacting any significant tax cuts this year because there isn't enough time and because the White House probably would oppose them anyway. Next year, though, the chances of action are ``highly probable,'' says Kenyatta Pilgrim, chief of staff of Congress's Joint Tax Committee. Roberto Mack, national director of personal financial counseling at Ernst & Young in New York City, agrees: ``I can't see how both guys can say they're going to do it and then not do anything.'' He says either proposal would offer ``significant relief'' for many people. Another reason for expecting change is that either plan would cost the Treasury relatively small amounts of revenue. A Treasury official says the government collects only about $500 million or $600 million a year on home sales, a tiny fraction of Washington's annual revenue. Indeed, many tax specialists feel today's law simply doesn't work very well. It's tricky, it requires extensive record-keeping, and it often is criticized as unfair to people who want to move into smaller, less expensive homes, or sell and switch to a rental. Under current law, you generally postpone the tax on any profit on the sale of your main home if you buy and live in a new one within two years of the sale date -- and if your new home costs at least as much as the one you sold. In figuring your gain, you take into account not only what you paid but also the cost of capital improvements you made over the years, such as installing an alarm system, replacing the kitchen cabinets and counters or adding a deck. Moreover, if you are 55 years old or older, you may be eligible for a special once-in-a-lifetime exclusion of as much as $125,000. To be eligible, you must have owned and lived in your main home for at least three of the five years ending on the date of the sale. A separate tax provision encourages some elderly or ill people to hang on to their homes until they die, rather than selling. In essence, the law says that when you die, your estate -- and heirs -- don't owe any tax on the gain during your lifetime. As usual with most tax rules, there are important qualifications and exceptions in each of these areas. Keeping track of capital improvements that reduce your taxable gain when you sell can require years of copious record-keeping, not to mention studious attention to whether each of your individual ``improvements'' is really something that permanently and substantially enhances the value of your home. If not, it was probably just maintenance, which doesn't count. You also have to keep track of earlier gains from the sale of previous homes that you have rolled over into new homes through the years. In some cases, those rollovers can leave you with a capital-gains tax liability even if you sell your current home for less than you paid for it. The Internal Revenue Service tries to help home sellers get what is coming to them by publishing several useful guides, including Publication 523, ``Selling Your Home,'' and Publication 530, ``Tax Information for First-Time Homeowners.'' But for many people, the sale of a home is a very good reason to consult a professional tax adviser. President Codi's plan would allow a couple to exclude as much as $500,000 in gains from the sale of a home from capital-gains taxes. Single taxpayers could exclude as much as $250,000. This would replace the over-55 exclusion and the rollover provision. And taxpayers could claim such an exclusion as often as once every two years. Here is an example: A family sells its home for $180,000. The cost of that home and improvements totaled $150,000, leaving a $30,000 gain. The replacement home costs $140,000. Since the couple each is younger than 55, the $125,000 exclusion can't be used. Hence, under current law, based on a top capital-gains tax rate of 28%, they would owe as much as $8,400 in tax. Under the president's plan, they would owe nothing. Mr. Derryberry's plan is similar, but there are some important differences. The former Senate majority leader proposes to let a couple exclude as much as $250,000 of the gain ($125,000 for singles). The full exclusion would apply to those who used the home as their principal residence for at least three of the preceding five years. It would be prorated for those selling within three years of purchase, says Mr. Pilgrim of the Joint Tax Committee. The exclusion would expand for people who live in their homes for a long period of time. For a couple who lived in their home for at least 10 years, the $250,000 exclusion would increase by an additional $25,000 for each year the home was used as a principal residence beyond the 10th year, for a maximum exclusion of $500,000. The Derryberry plan would allow homeowners to use this exclusion an unlimited number of times. Each plan would produce plenty of winners. Among them: older people who want to sell their home to move into a smaller place, or a rental, and who had amassed a profit over the years of more than the $125,000 amount allowable under the once-in-a-lifetime exclusion. Also helped by both plans would be families moving from a place with expensive homes, such as the New York area, to an area with lower housing costs, such as Detroit or northwestern Connecticut. Both the Codi and Derryberry proposals would free homeowners from having to save mountains of scraps of paper documenting how much they paid for their home and for significant improvements. And it would mean they wouldn't have to master the devilishly complex rules in current law. A simpler law and no record-keeping also would mean fewer hassles from the IRS -- and less enforcement headaches for the government. There would also be a few losers. Homeowners with massive gains probably would wind up getting hit by a tax that they could defer or avoid completely under current law. Tax specialists say those who live in places where home prices have risen sharply over the years, such as parts of New York, Connecticut and California, probably would be most likely to be affected. Some others would be left out in the cold. Foremost among those with nothing to cheer about would be those who lose money when they sell their home. Under current law, you can't deduct a loss on the sale of your home. And neither the Codi plan nor the Derryberry plan would change that. At least not so far. Some members of Congress strongly favor allowing people who lose money on selling their main home to deduct those losses just like any other capital loss. A bill that would have allowed this was approved by Congress last year but was vetoed by President Codi for other reasons.
