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Home Tax Break Comes at a Big Cost
For U.S., States

By Kenneth R. Harney
Saturday, October 4, 1997; Page E01

The annual cost of the new capital gains cuts for home sellers included in the 1997 federal tax bill finally have been toted up: American homeowners will pocket about $600 million from the bill during this year alone, and upwards of another $5 billion during the following nine years.

The new estimates of the expected revenue loss to the government are significant because they were never disclosed as a separate line item during congressional debate on the tax bill and because they appear to be substantially higher than the initial projections announced by the Clinton administration.

Last year administration sources said the home seller tax break would cost about $1.4 billion, spread over five years. The relatively modest revenue cost was one of the reasons why the home-sale provision received little scrutiny and critical analysis during this year's legislative process.

The new federal home capital gains "exclusion" allows sellers of principal residences on or after May 7, 1997, to pocket up to $500,000 (for married couples filing jointly) or $250,000 (for single filers) in gains tax-free, provided they've owned and lived in the home for two of the prior five years. The lucky sellers with gains greater than that would still have to pay taxes on the gains above the $500,000 and $250,000 thresholds. Sellers can use the tax-free exclusion once every two years, and can convert vacation homes or rental houses into principal residences to rack up additional tax-free gains.

A married couple in a high-cost real estate market, for instance, could take $500,000 in tax-free gains on a home sale in 1997, then move into their beach house for 24 months and sell it in 1999, reaping as much as another $500,000 of gain tax-free as well.

The new federal changes are so politically popular that almost no one has sought to determine how much they're going to add to the federal budget deficit. Housing and real estate trade groups never pushed congressional tax experts for revenue-loss numbers during debate on the 1997 tax bill because, as one lobbyist put it, "We were afraid to ask. It might be big enough to make some [tax committee] members think it's too expensive."

The only group that pushed for a specific number – and has just now received it – represents the 50 state tax-collecting authorities.

State governments have a direct concern about home-sale capital gains because the majority of them have state income tax systems that tie their definitions of taxable income to the federal system. They get a bite out of home-sale profits, as reported on taxpayers' federal filings. If there's no capital gain on the federal tax return, however, then there may be no taxable gain for state purposes.

Harley T. Duncan, head of the Federation of Tax Administrators, asked the congressional Joint Tax Committee for revenue-loss estimates so that the states and the District of Columbia could begin calculating what the side effects of the home-sale change would be on state and local coffers.

Of the 42 states with income taxes, 37 take the federal tax return as their starting point. Some of the states use federal definitions of income directly and take automatic tax bites out of that income. Other states do not automatically incorporate federal tax changes into their own systems.

California, for example, has had to take state legislative action to conform its capital gains treatment of home-sale profits to the new, more generous federal exclusion approach.

Duncan says such strict conformity can be costly to state treasuries – an estimated $100 million or more of lost revenue to California during the balance of the 1990s.

Although some states have the statutory power to continue collecting taxes on home-sale gains below the new exclusion ceilings of $250,000 and $500,000, Duncan says he doesn't believe any state legislature will do so.

"This is not an issue where people want to fall on their swords," he says, by forcing home sellers to pay taxes to state collectors on profits the federal government no longer recognizes as taxable.

So your tax-free home-sale gains appear to be safe, and larger than anyone imagined at both the federal and state levels.

© Copyright 1997 The Washington Post Company

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