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.
I. TAX DEFERRED EXCHANGES
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.
II. CAPITAL GAIN TAX RATES
1. Reduced Rates
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.
2. Holding Period
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.
3. Depreciation Recapture
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.
39.6% on gain from assets held for 12 months or less
28% on gain from assets held more than 12 months but not more than 18 months
20% on gain from assets held more than 18 months
18% on gain from real property acquired after December 31, 2000 and held for more than five years
25% on depreciation recapture
5. Installment Sales
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.
6. C Corporations
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%.
Selling Property
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%
III. PRINCIPAL RESIDENCE
1. New Capital Gain Tax Exclusion
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.
2. Gain in Excess of the Exclusion
Any gain in excess of the exclusion is taxable. It has been suggested that taxpayers with gaininexcess 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.
3. Holding Period
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.
4. §1034 Rollover Repealed
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.
5. Gap Period
Taxpayers who sell their residence between May 7, 1997 and August 4, 1997 can choose the §1034 treatment or the new exclusion rules.
6. Divorce or Separation
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.”
8. Reporting Requirement
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.
9. IRA Withdrawals
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.
IV. MISCELLANEOUS
1. Involuntary Conversions
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.
2. Collectibles
Gain from the sale of collectibles will continue to be taxed at the old capital gain rate of 28%.
3. Personal Property Exchanges
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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Property tax is levied against real estate by the government of the county in which the property is located. When a property is sold or transferred the County Assessor determines its assessed value for the purpose of taxation. The tax rate is applied to the assessed value to determine the annual property tax to be paid. Tax rates vary from neighborhood to neighborhood, in the Victor Valley it is typically around 1.25%.
In 1978 Californians voted in Proposition 13 which placed limits on how much property taxes could increase from year to year. Upon purchasing a new home the benefits of lower taxes would be lost as the new home was assessed at full value.
Proposition 60 permits a person over the age of 55 to sell their home, purchase a replacement of equal or lower value and transfer the assessed value of their old home to their new home. Both homes must be within the same county. This is a once in a lifetime exception, if either spouse has done it already then it cannot be done again. The sale and purchase must be completed within two years and both houses must be the owners principal residence.
Property tax assistance is available from the Franchise Tax Board if you are disabled, blind or at least 62 years of age and your total annual household income is less than $39,700. The amount of assistance is based on income and never has to be repaid.
Property taxes may be paid in two installments. The first installment is due on November 1 and it becomes delinquent on December 10. The second installment is due on February 1 and becomes delinquent on April 10.
When a property changes ownership, reassessment takes place immediately rather than waiting until the standard assessment date of January 1. The new assessment may be appealed. Assuming an increase in assessed value, the property tax that has already been paid by the previous owner is insufficient for the remainder of the term. To make up for the deficiency one or more supplemental tax bills will be issued depending upon the date the change of ownership occurred. The supplemental tax bill will be sent directly to the new owner and will not be paid by the lender even if the lender is paying the regular property tax bill by means of an impound account.
There is a homeowners exemption in the form of a $7000 reduction in assessed value available just for applying for it. The property must be the principal residence as of March 1. The homeowners exemption should be applied for between January 1 and April 15. It is also possible to claim the homeowners exemption on the supplemental assessment provided that it was not already in effect with the previous owner.
Special assessments may be levied to cover the cost of local improvements, for example sewers. These are included on your property tax bill but they are not subject to the provisions of proposition 13.
Another type of assessment is called Mello-Roos. These assessments are levied by a Community Facilities District, their purpose is to fund infrastructure needed before a development is built (such things as water, sewage, drainage and electricity). The Mello-Roos assessment is collected along with the general property tax but is not subject to Proposition 13 limitations. It remains in effect until the underlying bond is paid off.
