It’s called a migration.
That’s what will happen when homeowners all over America grasp the implications of the new $500,000 tax break for capital gains on residential real estate. The change, part of the budget and tax-cut deal made last week, will allow the house poor ( or real estate rich) to release equity tied up in a house and use it to:
- Leave an expensive, highly appreciated real estate area and move to a less expensive area, pocketing the difference;
- Scale down, tax free, as part of a retirement plan;
- Or take the income used to support one house and support two less expensive houses.
Instead of being called a budget bill, last weeks tax action would more appropriately be called The Tax Free Migration Act of 1997. It will enable millions of long term homeowners in high cost, high appreciation areas such as California and the Northeast, to make powerful rearrangements of their personal finances. It will do the same for people who have been very long term owners in areas that have not enjoyed such dramatic appreciation.
Consider a few examples:
Big Corporate Moves. Years ago, when J.C. Penney decided to move its headquarters from New York to Dallas, Penney employees faced an interesting dilemma. If they sold their high cost home in New York, New Jersey, or Connecticut and moved to Plano they would be “forced” to buy a large and luxurious home or pay a major capital gains tax bill.
If, for instance, they could sell a home in Montclair, New Jersey for $300,000 and replace it with a $200,000 home in Dallas, every dime of the $100,000 difference might be a realized capital gain that would have cost them $28,000 in federal income taxes. Many chose to buy houses beyond their wildest dreams instead.
Now consider the same move again. Moving from an area where houses are $200 to $300 a square foot to an area where they are $100 a foot presents a very pleasant choice: you can have a comparable house AND cash; you can have a lot more house; or you can have two houses. And all without a thought to taxes. Is this a great country, or what?
Watch corporate moves increase dramatically as firms realize that differences in regional housing prices are a powerful compensation tool, second only to stock options.
Tax Free Scale Downs. For decades we have been told to buy as much house as we could buy… and then buy more. As a result, millions of families own a lot more house than they need, particularly if they no longer have children at home. The alternative, for anyone under age 55, was to sell the big house and pay a major tax bill. If they were 55 and eligible for the old $125,000 capital gains exclusion, they faced a dilemma that was almost as bad: find every receipt for home improvements over ten, fifteen, or twenty years to keep the gain under the exclusion.
Now, scale down moves will be free of taxes, age considerations, and ( for most) record keeping. And the gains are palpable. Suppose, for instance, you are an empty nester couple with a $200,000 house that costs about $12,000 a year to operate. It would cost more but you have owned it long enough to pay off the mortgage.
That couple can sell the house and buy a smaller house for $100,000. The new house might cost $6,000 a year to support, a savings of $6,000 after-tax dollars a year. In addition, they would add a net of $88,000 to their retirement nest egg. Many people could do the same thing before the recent tax deal… but it was a lot more complicated and fraught with tax worry.
Own Two Houses Instead of One. Until now, tax fears may have kept many couples from buying a second home. Now, it will be possible to sell a large home and reinvest the proceeds in two homes without paying a dime in taxes. The first reaction of one Boston executive who is moving to the Southwest, for instance, was that the $150,000 price appreciation of the Boston Condo he bought for $350,000 two years ago might make it possible for him to have homes in Dallas and Hill Country.
But lets work with smaller figures. Suppose you owned a $250,000 home with $150,000 of equity. Under the old tax law, a move to a $150,000 primary house would have exposed capital gains up to $100,000. Under the new law, you could sell the house and buy a smaller home for $150,000. You could finance that home for $100,000, just like your former house. The transaction would be tax-free. Then you could pay cash for a $100,000 second home. The total cost of owning both homes would be about the same as owning a single home. Since one of the homes could be used for vacations, it would actually be more economical.
Basically, Congress has given us a free hand with housing choices… and a big boost to home ownership as an investment.
(The change is effective for home sales after May 7, 1997.)
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by Expect Best
(c) A.M. Universal, 1997