Tax Break for Homeowners...Sort of In light of the complexity added to many taxpayers' lives by the Taxpayer Relief Act of 1997, the new rules affecting the sale of a home provided a breath of simplicity. Still, some aspects of the rules require careful attention and planning by homeowners.

In a nutshell, most homeowners can sell their home without the worry of being taxed on any sales profits. Most married couples, filing jointly, can now shelter home-sale profits of up to $500,000 ($250,000 for singles), regardless of whether they buy another home. Before the act, homeowners had to reinvest those profits into another home within two years to defer taxes. People 55 and older could shelter up to $125,000 of gain, but that often involved complicated planning.

Now homeowners need to keep only these major rules in mind to take advantage of the tax break:

* They must have lived in the home at least two out of five years before the sale.

* They can take the full write-off only once every two years. They can take a pro-rated write-off if they must sell because of a job change, health or other unforeseen circumstance (for example, a 50 percent write-off if you move in one year).

The act is expected to especially help empty nesters who may want to move to a smaller home, retirees who may want to move to a smaller home or rent, and fixer-uppers who buy and renovate homes that need work and sell them for a nice profit. Now they won't have to roll over their entire profits to protect them. People who own rental property or a vacation home also can shelter them from capital gains taxes by selling their current residence, moving into one of the rental properties (or vacation home), living in it two years and selling it.

But the act won't help all homeowners, and for many homeowners there remain complications that they need to be aware of.

First, taxpayers who have expensive homes sitting with profits above the new limits will no longer be able to protect those profits by rolling them into an equally expensive home. Before, wealthy homeowners could keep rolling over the profits until they died, at which time the home could pass to their heirs free of any capital gains taxes. The new rules may lock wealthy homeowners into their current home or they may be forced to look at alternatives, such as donating the home to a charitable remainder trust. The only bright side is that the tax on the gains above the thresholds has been reduced to 20 percent if the home is owned at least 18 months. (The rate drops to 18 percent if the home is bought in the year 2001 or later and held at least 5 years).

Some homeowners may be able to still work under the old rollover rules as long as they sold or had a binding contract to sell the house before August 5, 1997, or if they'd bought a replacement residence on or before August 5, 1997.

Another complicated area involves homeowners who have taken a depreciation deduction for their residence, such as for a home office or because the property was used as rental property. The new act includes a depreciation recapture of 25 percent. Let's say you take $10,000 worth of depreciation deductions over the years for a home office. When the home is sold, even if there otherwise is no gain to be paid, you'll have to pay $2,500 on the recapture portion.

Also, homes sold for a loss still cannot take a tax deduction for their loss.

Don't pitch the paperwork, either. Experts historically have recommended that homeowners keep records of all home improvements in order to lower the gain subject to tax. While the paperwork will be less important for most homeowners under the new act, those facing potential taxes because the gain is more than $500,000 will want documentation. The same goes for people involved in a divorce or people forced to sell their home in less than two years. Also, some states will continue to tax capital gains on a home sale, so home improvement records remain important in those states.

The other bit of planning homeowners may want to do is to determine what to do with those profits they're no longer required to shelter. Do they roll them into another home anyway, or do they invest them in an alternative asset? Before making any home-selling decision, consult with your financial planner.

-30- October 1997

This column is produced by the Institute of Certified Financial Planners.