Federal Tax Amendments 1998
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Invest Web Homepage Public Law 105-206 of 1998, enacted July 22, 1998 and known as the Restructuring and Reform Act of 1998, was actually six acts in one. The majority of the new legislation reforms and reorganizes the IRS and provides taxpayers with many new rights and protections. Of particular importance to property owners and real estate investors, however, are those portions of the Act that:
1- amended the Taxpayer Relief Act of 1997 regarding capital gains tax rates and holding periods.
2- eliminated a marriage penalty making a couple filing a joint return ineligible for the universal exclusion because of ineligibility of only one of the spouses.
3- clarified how the universal exclusion is to be prorated when the seller of a primary residence has owned and occupied the property for less than years.
4- restricted the ability of the IRS to seize a primary residence as satisfaction for an unpaid tax liability.
Capital Gains Holding Periods and Tax Rates A "capital asset" is generally property which the owner holds with an intent to realize a profit through appreciation. In most instances, a gain or loss on the sale of such an asset is not recognized for income tax purposes until the taxpayer disposes of the asset. When any gain becomes taxable it may be eligible for preferential capital gains tax rates depending upon the length of time the asset has been owned; as holding periods become longer, the tax rates on gain decreases. Prior to the Taxpayer Relief Act of 1997, there were only two capital gains holding periods: 12 months or less; and over 12 months, which was considered "long tem." The Taxpayer Relief Act of 1997 created four holding periods as follows:
1- Short Term. 12 months or less.
2- Medium term. Over 12 months, but not over 19 months (effective for sates of assets on or after July 29, 1997).
3- Long term. Over I2 months, but not over five years (effective for sales of assets on or after July 29, 1997).
4- Over Five Years. Effective for sales of assets on or after January 1, 2001.
As a result of the Taxpayer Relief Act of 1997, taxpayers in 15% and 28% tax brackets found mid term gains to be taxed as ordinary income at their ordinary tax rates. Only taxpayers in tax brackets above 28% benefited from mid term gains, since the maximum tax rate was 28%. For long term gains, however, the maximum tax rate for a taxpayer in the 15% marginal bracket decreased to 10%; for taxpayers in 28% - and - higher brackets, the rate decreased to 20%. The latest legislation eliminates the mid term holding period retroactive to sales on or after January 1, 1998, and redefines "long term" as being over 12 months but not over five years. As a result of the "new" definition, all taxpayers now realize the preferential 10% and 20% tax rates when selling properties they have owned for over 12 months. Note that in certain instances the portion of gain attributable to depreciation taken on real property continues to be taxed at minimum rates of 15% and 25%. Universal Exclusion Marriage Penalty The newest legislation also eliminated the problem presented a married couple filing a joint return, when both are ineligible for the universal exclusion because one of the spouses does not meet all three of the eligibility tests. The Taxpayer Relief Act of 1997 eliminated a portion of the federal tax code granting certain tax benefits to those who sold their primary residences and realized gains from the sales. These former benefits were replaced by the "universal exclusion," which now allows single taxpayers to exclude from taxation up to $250,000 of gain from the sale of a primary residence, and married taxpayers up to $500,000 of gain To qualify for this exclusion, the taxpayer:
1- Must have owned the property for the two-year period immediately preceding the resale.
2- Must have occupied the property as a primary residence for an aggregate period of time totaling two years out of the five years immediately preceding the resale.
3- Cannot have used the universal exclusion for any sale within the two year period immediately preceding the resale.
As originally enacted, the Taxpayer Relief Act entitled married couple to qualify for the $500,000 exclusion if just one spouse could meet the ownership requirement, provided both met the occupancy requirement and neither used the exclusion within the two-year period immediately preceding the resale. The amendments address situations where both spouses cannot meet the occupancy requirement, or where one spouse has taken the exclusion within the two-year period immediately preceding the resale of the second property. For example, a man sells his home and takes the exclusion: six months later he remarries, and he and his new wife now want to sell her home; without the latest legislation, if they file jointly they are ineligible for the exclusion because he has already taken it within the preceding two years. Under the 1998 amendment, a married couple who file a joint return, but who together do not meet the requirements for the $500,000 exclusion, may use a joint exclusion that is the sum of the exclusions to which each of them would be entitled if they were not married. Universal Exclusion Prorations The Taxpayer Relief Act of 1997 also stated that a taxpayer who-due to changes in employment or health problems - cannot meet the eligibility requirements just mentioned, is entitled to a prorated share of the universal exclusion based on the fractional portion of the eligibility requirements met. From the time the previous act was passed, the IRS interpretation of the prorated exclusion seems to have differed from the intent of the legislators who passed the legislation. Consider the following example. Because of a job transfer, a single taxpayer resells her primary residence after only one year. and realizes a gain of $80,000. Had she owned and occupied the properly for two years prior to resale, she would be entitled to exclude up to $250,000 of her gain. She, however, meets only 50 percent of the exclusion's eligibility requirements.
THE LEGISLATORS' INTENT
She meets 50 percent of the eligibility requirements and is entitled to 50% of the full $250,000 exclusion, or $125,000. Therefore, her entire profit of $80,000 is exempt from taxes.
THE IRS INTERPRETATION
She meets 50 percent of the eligibility requirements and is entitled to exclude 50 percent of her profit from taxation. Therefore, $40,000 of her profit are exempt from taxes, and the remaining $40,000 are taxable.
IRS Seizures of Primary Residences The taxpayer rights section of the latest legislation severely restricts the ability of the IRS to seize property in satisfaction of an unpaid tax liability. Among other restrictions, the IRS can no longer seize real property used as the owner's primary residence - or any other real property of the taxpayer (other than rented properties) if used as a primary residence by any other individual if the unpaid tax liability including penalties and interest is $5,000 or less. In cases where the unpaid tax liability exceeds $5,000, the IRS must first obtain court approval before seizing a taxpayer's primary residence or the home of a taxpayer's spouse, former spouse or minor child. Invest Web Homepage |