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Ask investor Maxine Stone if she's aware of recent changes in tax law affecting capital gains, and she'll tell you it's why she just sold two rental houses. "You don't have to be quite as concerned about tax consequences when turning a property over," says the Oregon woman. Stone got into both properties at below market value, then did some minor repairs and cosmetic improvements. After holding them a little more than a year, she felt the time was right to sell. "In that neighborhood, the housing market was really hot." Thanks to the Taxpayers Relief Act of 1997, Stone will pay just 20 percent capital gains on her profits. "Before the new law, I would've had to keep the properties longer and then still paid more in taxes," says Stone, who used the money for remodeling her own home and to launch a gift shop. Many investors like Stone are taking advantage of the recent tax rulings, flipping properties as the market dictates or their own cash needs change. Instead of a 28 percent capital gains tax, several rates may now apply. For properties held at least 12 months, the new top rate is 20 percent. But for individuals in the 15 percent tax bracket, the rate on capital gains is just 10 percent. Properties held less than 12 months are taxed at a maximum short-term rate of 28 percent. An 18 percent rate for assets held longer than five years goes into effect in 2001, as does an 8 percent rate for those in the 15 percent tax bracket. Empty nestersInvestors too are watching how the new rulings affect people like Kathleen and Frank Johnson. When the last of the couple's four children left for college this fall, they found themselves living in a big, empty nest. Their sprawling (continued on page 2) six-bedroom, split-level outside Seattle was suddenly more house than they needed or wanted. But knowing they would show a profit of $350,000 or more in the sale, the Johnsons thought if they bought a smaller, less expensive place they would be hit with a huge capital gains tax. "We figured we'd have to stay put until we turned 55, or else reinvest all the money," Johnson says. "But we didn't want everything to go back into a house. We needed a new car and wanted to travel a little and help the kids out some." The couple was surprised to learn from their tax adviser that they could now sell their owner-occupied home and shelter all the profits from taxation. The new law scraps the rollover replacement rule that allowed profits to be deferred when a home of equal or greater value was purchased within two years. Gone too is the complicated one-time, over-55 exclusion of $125,000 in gain from the sale or exchange of a principal residence. Rules simplifiedThe new rules are much simpler. Part of the most dramatic tax reductions in 16 years, the law now provides a universal exclusion for gains made on the sale of a residence. Married couples filing joint tax returns may take up to $500,000 in gains, tax free. Single taxpayers may take up to $250,000. To qualify, the taxpayer must have lived in the home for least two of the five years preceding the sale. The exclusion can be used over and over, as often as every two years, which means buyers who choose to make an investment property their principal residence may also qualify. Rates loweredAny gains over the single $250,000 or the joint $500,000 limit will be taxed at 20 percent, down from 28 percent. Beginning in 2001, sellers who have occupied the home more than five years will qualify for an even lower rate of 18 percent on gains above the exclusion limits. The Johnsons now can base their decision about replacement home on factors other than taxes. This will have a significant impact on the real estate market as Baby Boomers edge toward retirement. These empty-nesters, like the Johnsons, may want to simplify their lives with smaller homes requiring less upkeep, a trend investors should keep in mind when buying single-family homes for resale. The Taxpayers Relief Act of 1997 contains more than 100 tax-reduction provisions. Changes in capital gains and the owner-occupant exclusion are but a few of the revisions making real estate an even better investment, bringing more buyers and capital into the marketplace.
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