Investment propertyThe Second-Home Subsidy Act
Tax preparers like to call the Taxpayer Relief
Act of 1997, the "The Tax Preparers" Full-Employment Act" because it
came with a complicated new round of tax rules.
But you could also call it the "Second Home Subsidy Act" because it
gave home owners some extra money and many used it to acquire a second home
for profit and for fun.
Second homes accounted for 5 to 10 percent of existing home sales
before the last turn of the century -- before the tax relief became
available. The data wasn"t accurate and may have been underestimated because
the sector wasn"t closely watched until years later.
However, by 2005, second homes accounted for nearly 40 percent of
all existing home sales. The National Association of Realtors says nearly a
third, 27.7 percent of all existing homes purchased in 2005 were for
investment purposes, while another 12.2 percent were for getaways, vacation
homes.
In the mix were investment homes and vacation homes that later
would become retirement homes and vacation homes that doubled as vacation
rentals when the owners were at their primary residence and other second
home uses.
Strong equity growth, windfalls from the pre-dot com bust stock
market, growing incomes, savings and general wealth growth among baby
boomers all helped fuel the seconds market.
The tax act was gravy, giving home sellers a greater share of their
returns to move up or down with enough cash left over for a second property.
Of all the tax breaks on the house the relief act has become the most
lucrative for home owners who use it.
When the 105th U.S. Congress passed H.R. 2014,
its key provision was a rule that says when you sell your home, if you
qualify, you can keep, tax free, capital gains of up to $500,000 if you are
married filing jointly or $250,000 for single taxpayers, or married
taxpayers who file separately.
To qualify for the $500,000/$250,000 exclusion, the home must have
been your primary residence for at least two of the last five years.
The two-year primary-residence-use requirement doesn"t even mean
you must physically occupy your home every day for 730 days.
If you are away on a business trip or on an around the world cruise
for several months, or otherwise not physically living in your primary
residence for relatively short periods, that doesn"t interrupt you from
meeting the two-year requirement.
If you"ve met the two year requirement and for whatever reason must
leave it vacant for extended periods, to retain the exclusion you"ll have to
sell it within the allotted five year period, or after five years are up,
move back in to reestablish the two year requirement.
If you have a second home where you live, go to work, send the kids
to school or otherwise treat as your primary residence, say every other
year, it will take you four years to qualify either or both homes.
"Theoretically, you have qualified both homes to exclude taxes on
the gain, but you can only take one and then must wait two years before you
can take the other," said Marie Sternberger, an enrolled agent in Sunnyvale,
CA.
The liberal law not only says you can take the exclusion on one
home every two years, provided you qualify with the residency requirements,
it also says you can take the exclusion as often as you meet the
qualifications.
For example, if you have a rental property you move into after
selling your first home and taking the exclusion, you can also exclude taxes
on the gain from the rental-turned-primary residence, provided again, you
meet the requirements.
You"ll have to recapture any depreciation (depreciation is taxed at
a federal tax rate of 25 percent) on the rental, of course.
Without the capital gains tax relief, you"d be paying a federal
capital gains tax at the rate of (5 to 15 percent) on your capital gains,
depending on your adjusted gross income.
Some states have varying provisions and continue to levy capital
gains taxes. California, for instance, taxes the gain as income with a
maximum tax rate of 9.3 percent.
The tax relief act also removed from the books, the $125,000 tax
exclusion on capital gains for home owners older than 55 and the "rollover"
law that allowed you to defer paying your taxes provided you purchased
another, more expensive home. Those federal laws are history.
A related law also makes provisions for you if, through some
unforeseen event, such as a job change, illness or some other hardship, you
are forced to sell before you meet the two-year residency requirement.
You can prorate the $500,000/$250,000 exclusion (not your specific
gain) if you are forced to sell early. That means if you only live in your
home a year before you are forced to sell, you can exclude from taxes up to
$250,000 in capital gains if you are married and file jointly or $125,000
for separate and single filers.