What follows is our understanding of the recent changes in the tax code. This outline is subject to change as we receive more information and clarification. Fidelity National 1031 Exchange Services, Inc. urges taxpayers to consult with their tax and legal advisors to evaluate how these changes may effect their specific situation.
There are no changes in the tax deferred exchange rules for the disposition of real property. None of the proposals this spring made it into the final budget and new tax laws. The like-kind requirement for real property exchanges continues to be very broadly defined. Exchangers still need Accommodators for simultaneous and delayed exchanges, and they still only have 45 days to identify replacement properties.
Effective May 7, 1997, most investors will see a 20% capital gain tax, down from 28%. Investors in the 15% tax bracket will actually see their capital gain rate reduced to 10%. Joint filers with an adjusted gross income of approximately $40,000 and single filers with an adjusted gross income of approximately $25,000 qualify for the 15% tax bracket.
Effective July 29, 1997, taxpayers must hold investments for more than 18 months, rather than l2 months, to qualify for the new long term capital gain rates. Properties held for more than 12 months, but not more than 18 months, will continue to be taxed at the old rates, 28% and 15%. Properties held 12 months or less are subject to ordinary income tax rates.
Depreciation recapture is no longer taxed at the capital gain rate. A new rate has been established. Most investors will pay 25% on depreciation recapture and, therefore, will be taxed at some combination of the 20% capital gain rate and 25% depreciation recapture rate. Taxpayers in the 15% tax bracket will pay 15%.
4. Purchases after December 31, 2000
Real Property purchased after December 31, 2000 and held for 5 years will qualify for a further reduced capital gain rate, which is 18% for most investors and 8% for those in the 15% tax bracket.
Example: High-income taxpayers may be subject to five different tax rates upon sale of assets.
Effective May 7, 1997, the portion of an installment payment representing principal will be taxed at a rate determined by the holding period of the property. Property held more than 18 months will be taxed at the new capital gain rates. The interest portion of the payment will continue to be taxed as ordinary income, perhaps as high as 39.6%. On property held more than 18 months, sellers offering seller financing may be motivated to increase the sale price and reduce the interest rate on the installment note so that more of the payment is taxed at the lower capital gain rate.
There are no changes in the capital gain rate for C corps. Capital gain is taxed at ordinary income tax rates, the maximum rate is 35%.
|
Period of Ownership |
Tax Bracket |
Old Tax Rate |
New Tax Rate |
| Held > 18 months |
28% or higher 15% |
28% 15% |
20% 10% |
| Held > 12 mo. < or equal to 18 months |
28% or higher 15% |
28% 15% |
28% 15% |
| Held < or equal to 12 months |
all brackets |
ordinary inc. tax |
ordinary inc. tax |
| Depreciation Recapture |
28% or higher 15% |
28% 15% |
25% 15% |
| Property Acquired After 12/31/20 |
28% or higher 15% |
28% 10% |
18% 8% |
Effective May 7, 1997, joint filers are permitted to exclude $500,000 from taxable gain. Single filers and married, filing separately, may exclude $250,000 from taxable gain. This exclusion is available every two years. It appears that boats, motor homes, trailers, etc. used as a principal residence will qualify for the exclusion. The exclusion is not available for depreciation that has been taken against the home for a home office or business.
Any gain in excess of the exclusion is taxable. It has been suggested that taxpayers with gain in excess of the exclusion continue to hold their property until their death when heirs would receive a step up in basis. The hope is that increased estate tax exclusions would protect the asset from estate tax.
To qualify for the exclusion the taxpayer must have owned and used the property as a principal residence for two of the last five years. Sales prior to August 5, 1999 which do not meet this requirement are eligible for a prorated exclusion.
The §1034 rollover has been repealed. There is no requirement that a residence be replaced within a two year period, forward and back, and therefore no benefit results from doing so. The one-time exclusion of $125,000 in gain has been eliminated, so there is no need or benefit to wait until age 55 to take advantage of the new exclusion rules.
Taxpayers who sell their residence between May 7, 1997 and August 4, 1997 can choose the §1034 treatment or the new exclusion rules.
Couples meeting the two following rules can each exclude up to $250,000 of gain:
(1) Either of the spouses meets the 2 of 5 years rule, and
(2) One of them is living in the property under a court decree.
If they fail to meet these requirements both must meet the 2 of 5 years rule in order for each to qualify for the $250,000 exclusion. If one spouse gets the house, that spouse may count the ex-spouse’s ownership and use toward the 2 of 5 years rule.
7. Job/Health Change or Other Unforeseen Circumstance
Taxpayers who must sell prior to meeting the holding requirement, due to job/health or other unforeseen circumstances, may qualify for a reduced exclusion. Future Treasury Regulations will clarify “other unforeseen circumstances.”
No reporting is required for the sale of a principal residence with gross sales price of $500,000 or less ($250,000 or less for single taxpayers). Instead, taxpayers must provide a “qualified written assurance” that the gain is exempt. If the taxpayer has taken depreciation against the home (due to business or investment use of the home) they willnot be able to provide such a statement.
Effective in 1998 tax payers may withdraw funds, penalty-free, from their IRA for themselves and lineal descendants who are first-time homebuyers. There is a lifetime limit of $10,000. First-time homebuyers are defined as not owning a residence in the previous two years.
If a taxpayer selling property subject to §1033 has gain in excess of $100,000 that taxpayer may not purchase replacement property from a related party.
Gain from the sale of collectibles will continue to be taxed at the old capital gain rate of 28%.
The only change to §1031 is for tax deferred exchanges of personal property. The new change provides that personal property predominantly used inside the United States will not be considered like-kind with personal property predominantly used outside the United States. The Internal Revenue Service will look at the use of the property in the two years prior to the exchange.
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