Holding Off the Glut From `Trading Down'

The capital-gains tax, though painful for individual home sellers whose house values have soared, may be preventing the collapse of the urban real-estate market

A GROWING anxiety has gripped urban and suburban America. A fraying social fabric - evidenced by gang violence, hour-long commutes on endless freeways, and the environmental degradation of the nation's large metropolitan centers - is kindling a new wave of migration.

If current homeowners can afford to escape, the coming flight from suburbia will have enormous economic impact far beyond the temporary effects of the current recession. But middle-class homeowners are boxed in by the curious logic of speculation and the tax code.

Throughout the speculative 1970s and 1980s, California was the peerless paradise for players of the real estate trade-up game. The median California home price had appreciated from $23,100 in 1968 to a whopping $194,010 in 1990, the peak year - an increase of more than 800 percent. Homeowners enjoyed similar gains in the Northeast. But in 1992, the outlook is radically different.

Consider the situation of a Los Angeles couple I know. In 1971 they began their climb to suburban affluence by purchasing a modest home for $38,000. Rapidly rising property values allowed them steadily to trade up to more spacious residences. By 1990 they had parlayed their initial investment into $475,000, the peak value of their present home.

My friends would love to cash out, purchase another house in a more remote and more satisfying location, then invest the remainder of their profits to pay off long-accumulating debts. In fact, they've made a small down payment on an idyllic lot in Washington state as a first step toward their eventual escape to fresh air.

Trouble is, they can't afford to sell. After taking all allowable deductions, and after buying a less expensive house, their total taxable gain would come to over $150,000, requiring a tax payment of at least $45,000 - in cash. That's money they don't have. Like too many Americans, they borrowed against the prospective gains tied up in their home and spent the proceeds on great vacations in Europe, fancy parties, new cars. The good life. They thought the music would go on forever.

But the tune has changed. The precipitous fall of California real- estate values since 1990 cut the value of my friends' house from $475,000 to $380,000. They "lost" $95,000 in capital appreciation. If that mini-crash hadn't occurred, they would have paid $28,500 in additional taxes on the lost appreciation, but $66,500 of it would have been left over. Even after additional closing costs, that remainder could have paid much of the taxes on their overall capital gain. Instead, they feel locked in place.

A cut in the capital-gains tax would break the logjam. But it might also break the California housing market. If the capital-gains tax were cut in half (that is, if my friends had to come up with only $22,500 for taxes) they'd probably sell their house. But so would thousands of others. Like my friends, other middle-class families want out badly enough to drive down the price of real estate.

More than 500,000 people left the state in 1990 (although their departure has been obscured by a sharply rising immigration of less affluent Mexicans, Latin Americans, and Asians). The stampede out of California is part of an exodus from suburbia occurring throughout America, a reversal of trends after World War II.

From 1950 to 1980, suburbia expanded its share of America's population by 7.5 percent in every decade. But by 1980, that rapid expansion came to a sudden halt. During the past decade, suburbia increased by less than 1 percent of the United States population. And even that slight increase was more apparent than real. Official census figures make it difficult to separate suburbia (where people are leaving) from the new utopia (where people are entering). If properly identified, the suburban share of US pop ulation in the '80s would show a decided decline.

The new favored places are anything but suburban; they are complexes of small, older towns beyond commuting range of large metropolitan areas. These are creating the new America of our future. Declining during the heyday of suburbanization, they began expanding rapidly after 1970. I call this new utopia "penturbia," for it contains cities of the fifth migration since the beginning of the industrial era.

One main barrier is preventing an even faster migration to penturbia: our high capital-gains tax. Except for that tax, today's accelerating migration to penturbia would be a rampaging flood. Reduce the capital-gains tax and a glut of properties would come on the suburban market - a vastly expanded supply accompanied by puny demand. The resulting fall in values would echo around the world.

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