UPDATE: The impact of this bill is not as first interpreted. Please visit Exeter for the most comprehensive analysis. Confirming that consulting an accountant is the best advice and that blogs are a fantastic way to work together for the greater good of factual knowledge. Thanks to Linda & Dan for their comments below in clarifying some of the exceptions and nuances to this bill.
Benefits for Buyers
The Housing and Economic Recovery Act of 2008 was recently passed and it included many positive things for buyers and sellers of real property. Highlights of the Housing and Economic Law:
* First Time Homebuyer tax credit up to $7,500
* FHA Foreclosure Rescue
* Prohibition of Seller-funded downpayment programs
* Conforming loan limit increases to $625,000 in high-cost areas
* Neighborhood revitalization funds (up to $4 Billion)
The highlights have been covered by national and local media and almost every real estate blogger has the details on their site. For those looking for the basics of the law, then visit NAR’s summary, but here at AgentGenius, you’re going to get the details that have yet to be REvealed.
Paid for by Sellers
Buried deep on page 690 of the 694 page law is an important change to the Capital Gains Exclusion rule that could cost home sellers across the country. Under the former Capital Gains Exclusion rule, home sellers could claim $250,000 of home sale profits tax-free ($500,000 if filing jointly) provided they physically lived in the home for 2 of the previous 5 years.
Under the new Capital Gains Exclusion rule it’s no longer an all-or-nothing proposition instead, it’s a ratio.
In other words, if a home seller occupied a property as a primary residence in 2 of the last 5 years under the new system, he would be entitled to 40% of his capital gains tax-free versus 100 percent of those gains before the new housing law passed.
The effective date for the new Capital Gains Exclusion rules is January 1, 2009 so homeowners selling in 2008 are exempt.
You bought a home in January 15 2004 and paid $500,000. This has been your primary residence until this year, January 15 2008, when you bought another property and moved your primary residence. Say you sell your original property next year, January 15 2009, for $600,000. Your capital gains are $100,000. Your capital gains exemption formula:
1460 / 1825 = 0.80 x $100,000 = $80,000 Capital Gains Exclusion
Which means you would pay capital gains tax on $20,000. Capital Gains Tax is currently at 15%, so you would pay $3,000 in new taxes that you would have avoided prior to this new law. *Please note this does not account for the state portion of capital gains, In Georgia that would be an additional 6% of the gains or $1,200 for a total of $4,200 in taxes on the gain.
It may sound like a small number when you profit $100,000 to only pay $4200, but what happens if the new government leaders change the Capital Gains Rate? This rate has been as high as 45.5 percent in the past. This is not good for future sellers of real estate.
– How will the IRS determine a finite ‘primary residence’ date? We will need an actual date to calculate capital gains. Current rules are very vague and do not call for exact dates of ‘primary residence’ declaration.
– Who benefits most? The super-rich because they can now claim exemptions they previously were not qualified for (over $250,000 gain is much more likely in Million Dollar plus price points) or the long-term property owner who sells his farm for millions of dollars that he only paid hundreds for?
– Who is penalized the most? The average homeowner who buys a new home prior to selling their existing. What if she has to rent it out for a year or tow ride out the market and then sell it? Now she’s paying capital gains that she never would have considered under the old rule.
What other concerns do you have about this change? Are you scared to find out what else is not being REvealed in this new law?
h/t Dan Green
August 5, 2008 at 9:56 am
Brad; I have to tell you , I think the Capital Gains issue is not a really big issue. Though I understand the perspective of the change from the current really sweet law, but the amount of the tax is, as you pont out relatively small, and with the exception of someone who moved from one property to another while still retaining the first, I think the impact is nil. Using your example, the effective Federal tax rate was only 3% of the capital gain by the homeowner – a truly nominal amount of money – (its really not fair to add in the State taxes, since they are not impacted by the new bill and as you point out vary from state to state)
I do appreciate your concern about the Capital Gains tax rate, but when the rate was higher, Capital Gains was deferred from home to home, and then a one time exemption was granted. If the congress moves to higher capital gains tax rates, I would suggest that NAR, NAHB, and other impacted groups would lobby agressively for some similar treatment.
In fact, in light of the other beneficial terms of the bill, I would be forced to say that this is a very small price to pay for the solid benefits of the package. But hey then again, I’m just a half’full glass kind of guy! 😉
August 5, 2008 at 9:57 am
I had always been led to believe that if 100% of the gains from the sale of House #1 went towards purchase of house #2, with none left over, there is no gains tax – is this incorrect?
August 5, 2008 at 9:59 am
Thanks for the info Brad. I didn’t get to page 690 so I would have missed this without your deep dig. This is really bad for me personally. Not because my home is not my primary residence but because I don’t think I will ever see that $500,000 home sale profit. I wonder if this will impact Q3 & Q4 sales here in the Bay Area where long-time residences still could see huge gains even with the dip in the market.
August 5, 2008 at 10:17 am
@Bill I don’t think Sellers will agree that $4,200 is a “nominal amount of money”. But more importantly Capital Gains can’t be dismissed as “not a really big issue”, too many Sellers will be affected by this change for it to be a small detail overlooked by the media. Furthermore, I feel it is especially valuable information for Realtors to pass along to their clients. I can see many Sellers being pissed off that their agent didn’t mention the Capital Gains they had to pay after the sale, with repairs and concessions, and after commissions. It is better to KNOW more now than find out the hard way by loss of business.
I chose a simple and random example with conservative numbers. But regardless of the amount of gains to pay, the fact is this is a NEW TAX for many Sellers of real property. In fact, it’s a tax on someone’s ‘private residence’. I just can’t believe this country allows more taxes to be hidden in laws without bringing to everyone’s attention. Politicians should be held accountable for all new taxations, but I digress. The point here is to make sure that the public and Realtors know about this slight of hand and inform all applicable Sellers of the NEW TAX CONSEQUENCES of selling a former ‘primary residence’.
Many homeowners have built up equity by buying fixer-uppers, living in them for 2 years, then renting them out and/or flipping up to a bigger and better home. Sweat equity was highly rewarded under the old $250,000 gain exemption, but now it is diminished by a new tax.
@Derek The amount of profit no longer matters with the new calculation. If you make $15 profit, then it will be applied to the formula to calculate capital gains tax owed. This sounds like a new tax for the middle class to me. But you are exactly right in your concern for impact. I would say if the Sellers of a former ‘primary residence’ have less than a $250,000 gain, then they would be better selling by the end of 2008. If they have more than a $250,000 gain, it seems better to wait until 2009.
August 5, 2008 at 10:44 am
The headlines giveth and the fine print taketh away!
Another hidden point that a lot of the people pushing this first time homebuyer $7500 tax credit don’t bother to mention that the so called “credit” has to be paid back at $500/year for 15 years from your taxes and in a lump sum if you sell before the 15 years are up. That doesn’t sound like a credit to me!
Thanks for the heads up on this. I agree that a change in the basic homeowners tax credits should be disclosed to the citizens, not buried in the fine print of a document the average person couldn’t understand.
August 5, 2008 at 12:26 pm
Bill – ‘…in light of the other beneficial terms of the bill, I would be forced to say that this is a very small price to pay for the solid benefits of the package’. I would argue the ‘solid benefitsof the bill.
The 400,000 homeowners that will supposedly be able to work with lenders on existing mortgages seems like a joke. It’s entirely voluntary and I’m not sure how many lenders are lining up to reduce the interest rates for those homeowners.
As Dan points out the $7500 tax credit won’t feel like such a great thing when they go to sell in 4 years and have to pay back the $5500. It’s nice to have the interest free loan as long as the consumer fully understands it but it is a loan and not just a tax credit.
And this Capital Gains issue is muddy. The Consumer still gets confused about the old Capital Gains law as Jack shows here thinking that a rollover still exists. This further complicates it with this crazy calculation. I would agree that $4200 will feel far from nominal when the Consumer remembers that is was $0. And it also feels like a big roll of the dice given the coming election and the frequent talks of a Capital Gain tax hike.
This ‘feel good’ bill seems like a bit of a con to me. I don’t see this a tool assisting in the market recovery. We are in a cycle – albeit a tough one – and this bill isn’t going to change the recovery. The cycle is just going to have to run its course. I hope Realtors and lenders help to educate about all the ‘benefits’ and implications of these tools for their clients so there are no suprises.
August 5, 2008 at 3:00 pm
Brad, thank you for making light of the capital gains change. I have renamed it “the part of the Housing Bill the media forgot”. I included basic information about it in my August Newsleter email that I sent out today. The response was overwhelming with people asking for basic infomration and wanting more information.
August 5, 2008 at 6:25 pm
I went through the bill (and like some) did not get to page 694. I think that members of the House and Senate should actually READ every bill they vote on and they should publish them online 24 hours before the vote.
Net result: Less bills (good), less legal mumbo jumbo and fine print (good), bloggers would be able to point this kinda crap out BEFORE the final vote…(very good).
Mack in Atlanta
August 5, 2008 at 7:23 pm
@Eric-I doubt that any of our wonderful legislators got to page 694 either.
@Dan-It is actually an interest free loan from the government that is repaid via income taxes. I was in a meeting today and this topic came up. What was stated was that a taxpayer who owes $1,000 in taxes this year could file and get the $1,000 reduced to 0 and still get a refund of $6,500 that would be repaid $500 per year for 15 years interest free. Sounds like you and I and everyone else who pays taxes gets to fund this election year headline!
August 5, 2008 at 7:31 pm
Completely agree with you Brad on the capital gains issue. I have to disagree with one of your other points however.
You listed the elimination of seller funded down payment assistance as a benefit of this bill. That provision is not a plus for either party. In my market, it effectively shuts out 8% – 10% of all buyers. That hurts sellers too. Granted the effect will not be so pronounced in many markets, but keeping these programs in place would have no effect either.
Some will argue that these type of programs have caused part of the foreclosure problem we are now facing. I have yet to see any study that supports that theory.
Overall, Congress didn’t do much more than make a lot of noise with this legislation.
August 5, 2008 at 8:12 pm
Thanks for the hat tip, Brad. And, as always, it’s probably a good idea to have your clients talk with their accountants about the tax law changes and how it may impact their personal returns.
August 5, 2008 at 9:46 pm
In light of the changes to the treatment of capital gains and the muddy definition of a primary residence with this bill, if you do short sales, it is even more crucial that you make sure your sellers consult with a tax expert first. It is on this basis that I would disagree with Bill on the impact.
Classic example of unintended consequences.
August 6, 2008 at 5:23 am
I am with Charles on this one, one of the biggest changes that will affect us locally is the elimination of seller paid DPA. Whether or not is should be allowed is very debatable, but what is not is that this will really hurt the first time home buyer section of the market. Now might be a good time to pick up a few rentals.
August 6, 2008 at 5:50 am
@Charles & @Mike There is no doubt the change in DPA will have a huge impact on what first-time Buyers are able purchase. However, it’s easy to argue that we may not see as many foreclosures if we forced Buyers to actually put down some money themselves when buying a home. It’s a sticky area when buyers and sellers start inflating sales prices for buyers to be able to buy a home. As I typed that last sentence, it just stabbed me with a WRONG feeling. Does it really sound like a good idea to Inflate a Sales Price for buyers to be able to Afford a home?
Mack in Atlanta
August 6, 2008 at 6:05 am
@Brad-In today’s market who is inflating a price? I have worked with quite a few buyers who have super credit and no cash for a down payment. In structuring their transaction the closing costs (up to 6% on FHA Loans) and the DPA all came of list price. The exception to this is the foreclosure home that is priced at $25,000 below market where the DPA was added to the list price. The biggest problem with DPA is that HUD doesn’t like it. Buyer’s can still use gift funds form a relative to purchase a home but guess what, they still don’t have any of their money in the game when doing this. For a lot of these buyer’s, family just doesn’t have an extra $5,000 sitting around, where the sellers may be willing to assist in order to get their home sold.
August 6, 2008 at 6:14 am
@Mack inflating may have been a poor choice of words, but we all know the DPA buyer is paying more than a non-DPA buyer regardless of list price. I may be looking at this from my bank director’s role, but I am much more confident a buyer will pay pack a loan when they actually have some skin in the game themselves. If they can’t save up the $5,000 (in your example) to buy a home, then perhaps they should rent until they can.
Mack in Atlanta
August 6, 2008 at 6:19 am
“If they can’t save up the $5,000 (in your example) to buy a home, then perhaps they should rent until they can.”
Now that certainly will help with the housing market won’t it?
Glenn fm Naples
August 6, 2008 at 6:36 am
I visited Dan’s site to download the whole bill for my casually reading pleasure. Dan’s site is one of the only places where one could actually find the entire bill.
Calls to US Senators offices – revealed their staffs could not tell me where to find the bill online to download – so much for improving the system – BTW, maybe the Congresspersons do not read the bills???
Glenn fm Naples
August 6, 2008 at 6:41 am
Brad, Mack, Mike – an old time CEO and Chairman of the Board from a bank once told me the following:
When we make a loan for someone to buy a home, we look at 3 things: 1) Do they pay their current bills on a timely basis? 2) Do they make enough money to pay the new debt and old debts and still survive? 3) Is there enough collateral to cover the loan should we have to foreclose on the property?
Maybe these 3 questions if applied and answered properly, then we might be in the situation we are currently in?
August 6, 2008 at 4:14 pm
This bill has its problems. The downpayment assistance programs are great for first time home buyers! Without it, many will not be able to afford a 3.5% downpayment. These programs help our housing industry.
The capitol gains tax reform is a topic that can be debated on from both sides of the fence. Small investors will be hurt. And home owners that are relocated but can’t sell their home will be hurt as well.
August 7, 2008 at 5:33 pm
@Brad and Glenn – Inflated sales price or not, I am not really sure I can come up with too many arguments why people should be allowed to purchase a home with zero money into the deal. IMO it is the right thing to do to eliminate DPA, it is just going to badly hurt the first time homebuyer market at a very vulnerable time.
August 7, 2008 at 6:53 pm
I’m with Mike on this one. A step forward at an awkward time.
August 8, 2008 at 11:45 am
We have had a resort area rental property for 10 years. We just sold our home and moved in to the rental property due to the capital gains exclusion. Over 10 years the property has appreciated 250%. We would have sold years ago if we thought the law would change overnight – but now there are no buyers. The law will cost us $50,000. As a retiree I was counting on the gains. Why do I have to pay to bail out ignorant buyers and crooked lenders? The law will kill the resort area second homes and rentals markets.
August 12, 2008 at 2:10 am
I consider this new Law a slap on my face, because for people who are enjoying life without the money to do it, just pulling out an inexistent equity, they have bought cars and expended money traveling or just partying. I drive an old truck because counting on the old Law I was hopping to buy another house for which we have been saving to put a 20% down, and then rent this small house for three years now thanks to this stupid people ( I don’t blame the lenders they did not force anyone to sign the papers) now we are going to have to pay taxes, for trying to be decent citizens and not to abuse the credit system this is really frustrating.
August 12, 2008 at 8:34 pm
Anything that is or becomes part of the US tax code by definition is so contrived it rarely achieves the goal it was inteded to reach. The code 30,000+ pages in its entirety is patently unfair, horrible when measured for efficiency. Cannot be uniformly enforced; and worst of all does not fund to needs of government…
This latest addition is no worse and no better than most of the concepts that are already reside in their mutated form in our tax laws. Just my thoughts 🙂
August 13, 2008 at 8:09 am
There are those who have has been trying to eliminate the mortgage deduction for a while. The change to the second home rule was merely the first bite at the apple.
August 16, 2008 at 6:03 pm
I question whether your interpretation of this bill is correct. As I understand it, if someone lives in the house first, and then rents it out later, this new rule won’t apply. The new rule only applies in the reverse situation where you first rent out the house (or it is a second home) and then you move in later and make it your primary residence before the sale. So, in your sample equation, there would be no capital gains taxes, not $4,200 as you say. Also, you say that the super-rich will benefit most with the implication that they can deduct more than $250K/$500K of gain. I believe that the $250K and $500K limits still apply.
August 16, 2008 at 6:51 pm
@Linda. I appreciate your thoughts on this subject, but my interpretation and differs from yours. Why would they create a more complex formula for property owners and then keep the caps in place (thereby nullifying the formula for 90% of the population)? The new rule says nothing about what order the ‘primary residence’ (PR) is declared (first or last). It simply creates a percentage of time occupied as PR vs time owned. There would be no point in determining if it was leased prior to or after being a PR.
I challenge you to prove me wrong. I think many Americans would love for me to be wrong (and I hope I am too), because this will cost many Sellers. However, I just can’t interpret it any other way.
August 16, 2008 at 7:09 pm
My understanding of the purpose of this bill was to prevent property owners from moving into their rental property or second home for two years and then being able to take full advantage of the exclusions. I believe that the $250K/$500K caps are still in place because the new bill adds a new paragraph (4) to subsection (b) of IRS Code Section 121 and leaves paragraphs (1) and (2) in place. Paragraphs (1) and (2) have the $250K and $500K limits. Subparagraph (C) (ii)(I) of the new bill says that the “period of nonqualified use” does NOT include any part of the 5-year ownership period which is AFTER the last date that the property is used as the principal residence. I was doing an internet search about the capital gains aspect of this bill and came across several articles and downloaded pages 690-693 of the bill, the existing section 121, and the following article by Kathleen Pender dated August 3, 2008, from sfgate.com: https://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2008/08/03/BUQO123386.DTL&hw=kathleen+pender&sn=011&sc=554. This article is consistent with my interpretation of the bill.
August 16, 2008 at 7:36 pm
Hi guys, let me see if have understood what you said, We have live in our house for 13 years but we have a little house we were renting for 3 o 4 years now me mother lives on it for I guess three years or a little more if she keeps on living in there and we want to sell the property in said two years, can we qualified for the 121 code? And can we keep all the equity we have in our home?
Thank’s for your advice?
August 16, 2008 at 7:37 pm
My understanding was this is a way to pay for the benefits given to buyers by taxing the second-home property owners. After reading your conclusions, I think I will talk to an attorney and/or accountant next week and update everyone with a new post. The bill will obviously affect fewer people under your interpretation, but it is still a new tax expense that would have been avoided under the old rules.
Thank you for your diligence and this is great proof int he power of the blog platform. It allows information to be presented, vetted out publicly and corrected (if need be). I promise to dig deeper from here and report back next week.
August 16, 2008 at 7:39 pm
@Juan It is my understanding that your mother will be considered a ‘tenant’ and that you yourself must live int he property 2 of the previous 5 years to be eligible for any capital exemptions.
August 16, 2008 at 7:56 pm
Ok, but we claim her as our dependent in our income tax, now she doesn’t pay any rent and in our income tax we report that house as not rented, so what do you think? 10Q.
August 16, 2008 at 8:24 pm
@Juan You definitely need to contact your accountant (or even better a tax attorney). I don’t think you can create a more unique situation for this rule to be applied.
August 16, 2008 at 8:55 pm
Here is a quote from the bill:
Exception #1 looks to me like Linda is right about this. Hopefully she is!
August 16, 2008 at 9:07 pm
I agree exception #1 makes Linda right. However, it does not change the impact of this bill very much. Granted some people move back in to a house to reclaim it as a ‘primary residence’, but this is the least common tactic by most second home owners.
Many people (especially in today’s market) have purchased a new PR and then tried to sell their former PR. Having to fight a declining market forced many of the second home owners to rent their property to ride out this downturn. Now the government will be taxing gains from them when they sell it (unless they follow the exception and move back in, but what does that do to the newer PR?)
I acknowledge my mistake in overlooking Exception (i), but still find that this bill creates a new tax on many owners who should not responsible for bailing out other people’s errors.
August 16, 2008 at 10:06 pm
I don’t want to keep going back and forth on this, so this will be my last post. I found another article which explains the tax free exclusion of capital gains in the new law in greater detail. The article clarifies the issues we have been discussing. Check this out: https://www.exeterco.com/article_changes_to_section_121.aspx.
I agree that the new law creates a new tax for a certain group of owners, but not for those owners who have bought a new personal residence before selling their old personal residence. If the old personal residence is rented out instead of being sold right away, but it is sold within three years of the move into the new personal residence, the gain can still be excluded up to the $250K/$500K limits. These owners are not included in the new provisions. It is those owners who buy an investment home (or vacation home) and then later convert it into a personal residence who are stuck. These owners will only be able to exclude the gain for the period in which the property was actually their personal residence, and not for the earlier period in which the property had been a rental or vacation home. Example under old law: Someone owns a residence and then buys a second property (a rental property or summer home) and holds it for three years. After the three years, they sell their personal residence and exclude the gain up to the $250K/$500K limits, move into the rental property or summer home and then sell it after two years and again exclude up to $250K/$500K in gain. Under the new law, this owner can still exclude up to $250K or $500K on the sale of the first residence, but could only exclude 2/5 of the gain (but no more than $250K or $500K) on the sale of the second home, which had originally been a rental or summer home.
August 16, 2008 at 10:24 pm
Fantastic research. Exeter has the most in=depth coverage I have seen yet on this topic.
With these clarifications, it seems the government has tried to prevent ‘flippers’ from buying real estate, renting it out for a period of time and renovating the property, then living in it for the 2 year requirement prior to selling it to avoid paying gains tax. I don’t how many people this will affect at this point, but I don’t think it is a significant portion of the population.
August 17, 2008 at 10:12 am
Nice work Linda.
August 17, 2008 at 8:20 pm
Here is another source of analysis on the bill. https://tax.cchgroup.com/legislation/2008-Housing-Assistance-Act.pdf
This article pointed out an important aspect of this, which is that the new law is based only on nonqualified use periods that begin on or after January 1, 2009. So it actually doesn’t affect the plans people have made up until now. The article goes on to say:
So now it appears that the purchase of investment property that you live in for two out of five years may still work for the capital gains exclusions if you live in it for the first two years. I look forward to hearing some clarifications from a CPA or tax attorney.
August 17, 2008 at 9:49 pm
Dan, CCH sells their analysis of tax law to CPAs and attorneys (it is a subscription service to help the guys stay current on the law), so you’ll likely find that they’ll agree with this.
September 15, 2008 at 7:05 am
We are in a predictament. We bought a home in Aug of 2005. We have tried for the last 3 yrs to sell our first home. (2 times we had it on the market while being rented) We still have not sold the property. we are beyond the 2 out of 5 yr timeline. If we sell it now we will need to pay capital gains taxes on 250K. All because of someone else’s mistakes (mortgage co, banks)our home has not sold. The govt is bailing everyone else out but the normal average person who is caught in our situation. Have you heard of anything that has extended the time to sell a property to 5 yrs after you moved out and not 3 yrs in order not to pay capital gains? Could the 5 testing period include that as well? Wishful thinking
September 15, 2008 at 8:47 am
There are not any extensions available that I know of. However, it is important to remember that you only pay Capital Gains taxes if you actually have a gain and having a gain in this market is an accomplishment, so paying taxes shouldn’t be considered all that bad. Remember, you only pay cap. gains tax on the amount of gain, not total sales price.
September 15, 2008 at 8:52 am
Sharon, anything will sell at the right price, so if your home still hasn’t sold, you need to examine the price. The only other factor aside from price would be access, meaning you could have had it priced right but a tenant could have created a limited access situation. I’m curious if you tried to sell it before you rented it out. If so, once you put a tenant in to the property, to many agents, that speaks to the willingness to price it right.
I know you didnt ask about pricing advice, but I addressed that first because the tax question is moot if the property doesn’t sell.
The current law hasn’t changed in any way that would increase your time frames on the first property. You could change the dynamics by moving back into it long enough to get back within the 2 out of 5, but you may create issues with the 2nd home if you have to sell it. However, given that you bought the property in 2005, my guess is that capital gains would not be much of an issue, if any.
December 17, 2008 at 10:16 pm
I purchased a condo in 2002. I lived there until 7/08. I am currently renting the condo with a 2 year lease. If I sold the unit today, I estimate my gain would be $200k. Given current market conditions, let’s assume that my gain on 7/10 is still $200k. Do the 19 months after 1/09 still need to be allocated to the gain, all of which occured before 1/09?
January 3, 2009 at 9:37 pm
I am confused on what happens if the property was originally a primary residence for several years, later a rental (for longer than 5 years) and then later again (after Jan. 1 2009) becomes the primary residence again. If we then live in the house 2 more years, do we not need to count the rental time, since its original use was as a primary residence, or do we end up wanting to move back to this house ASAP so that our somewhat substantial taxable gains are minimized?