The new tax bill holds genuine relief for many homeowners. They are no longer trapped into ever bigger mortgages.

You Choose Now: What to Do With Home Profits

August 18, 1997

For years, the Batemans did the real estate shuffle - buying a home, selling it, then rolling the profit into another, more expensive home.

Uncle Sam encouraged it, because he didn't tax the profits so long as they bought a home that cost as much as or more than the one they were selling.

And it worked for the Batemans, who live in a suburb outside Boston, giving them constantly bigger, more expensive homes to house a growing family.

Then it didn't work anymore. "The kids are grown," says Robert Bateman. "We don't need something this big, and, frankly, we'd like a smaller mortgage."

But a cheaper home would have meant a huge tax on the profits they'D accumulated in their home sales.

The new tax bill just signed into law comes to their rescue. It not longer requires American families to constantly "trade up" in real estate.

Families like the Batemans can now sell a home and do whatever they want with up to $500,000 in profits, tax free.

Most homeowners got a windfall in Washington's new tax bill.

The new law exempts up to $500,000 from capital gains taxes if a couple sells their primary home. Singles get a $250,000 exemption.

Capital gains are profits, a positive difference between what you paid for an asset and what you sold it for. The new tax bill eliminates taxes on all except unusually high capital gains when you sell your primary residence and lowers them on other investments.

In either case, the exemption can be taken every two years and no longer just at retirement age.

"There aren't many downsides to it," says Jonathan Pond, president of Financial Planning Information in Watertown, Mass.

"Generally, this is going to avoid capital gains taxes on the homes of most people," says Sherwin Simmons, a tax lawyer in Ft. Lauderdale, Fla.

Those who stand to gain the most are young people and homeowners who move a lot.

"This is going to help the young, upwardly mobile, and it may help transience in the job market," says Scott Newman, head of the tax department at the law firm Whitman Breed Abbott & Morgan in New York.

The changes eliminate a couple of expensive elements in the old tax code:

1. You could skip paying taxes on $125,000 in home profits if you were over 55. This provision allowed people to trade down to smaller homes in retirement.

2. You could defer taxes on profits if you bought a home of equal or greater price within two years.

But while the new law saves most homeowners big bucks, up to $140,000, a few will still get stuck with a bill.

Homeowners who have been in their homes a long time and realized more than $500,000 gain, for example, will pay a capital gains tax even if they trade up.

And those who have continually traded up, deferring taxes and amassing more than the limit, will owe money.

Many of the country's big cities have seen large gains in real estate values over the past 25 years. Under the old rules, these homeowners could have deferred the tax again by buying another more expensive house.

In the long run, however, even many of these people may have lower bills.

Say a couple bought a modest home in Beverly Hills, Calif. in 1972 for $35,000, and now the property is worth $750,000 (not an unlikely development).

If the couple sold the house now, they could no longer defer capital gains taxes on it. They would owe approximately $43,000: 20 percent of $215,000 profit above $500,000.

But under the old rules, if the couple sold to buy a smaller place, retire to Phoenix, or even move to a cheaper housing market (almost anywhere else), they would have owed more, Mr. Simmons notes. They could only have excluded $125,000 of the gain if they were over 55, not the $500,000, and would have owed $68,000 to Uncle Sam.

"The people this is best for are people who want to downsize or rent," says Mr. Pond.

Homeowners get some tax benefit even if they can't meet the two-year requirement. Normally, you have to live in a house for two of the past five years.

But under the new law, homeowners can get a pro-rated exclusion based on their time in a house, as long as they have to move for their job or health reasons - or what the new law terms "unforeseen circumstances."

So if you live in a house six months before taking a new job elsewhere, you could exclude 25 percent of the profit from capital gains tax, Simmons says.

Specifics, such as the distance to the new job and what constitutes an "unforeseen circumstance," should be defined in the next two or three weeks, Simmons says.

Those who use their homes for business or rent out a portion of them don't fare as well.

When a portion of a property is depreciated for business, the depreciation amount is taxed at a higher 25 percent rate, and the $500,000 exemption for a primary residence doesn't apply to that portion of the property.

If you planned to sell your house before the new law took effect, you may be able to defer the capital gains tax under the old law as long as you signed a contract to sell it by Aug. 5. The transitional rules also allow you to apply the new law if you prefer.

In all, Pond says the new law is a bonus. "You no longer have the tax tail wagging the dog," he says.

HIGHLIGHTS OF THE NEW LAW:

* $500,000 exemption from tax on profits (capital gains) from the sale of a "primary residence."

* $250,000 profit-tax exemption for singles.

* Principal residence defined as your home for two of the last five years. (either spouse, if divorced).

* You can take the tax exemption every two years.

* 20 percent tax rate on profits over those amounts.

* 25 percent rate for property depreciated for business.

* If you've lived in the house less than two years but had to move for "unforeseen circumstances" (job change or health reasons), you can take a discounted tax exemption.

* Sellers with homes under contract before Aug. 5, can choose the old or new law.

Winners and Losers in the New Tax Bill

Most of the actual rules have yet to be written for the Tax Relief Act of 1997, and experts expect them to emerge over the coming weeks and months.

But some people have already emerged as clear winners, and losers, in this new bill.

Winners

* Most homeowners. They can now avoid taxes on up to $500,000 in profits on home sales.

* People who trade down in home price and mortgage. They no longer face a big tax bill for not moving up in the neighborhood.

* Real estate investors, home fixer-uppers. If they buy homes, fix them up and sell them for a profit after living in them at least two years, their income is tax free.

Losers

* Wealthy homeowners who have more than $500,000 in profits in their homes.

* Homeowners who stayed put and whose homes have appreciated substantially.

* Home business owners who take tax write-offs on part of their homes. The new law is less generous and in some cases penalizes them.

* Real estate brokers who sell expensive homes. The jury is still out, but they could see a drop off in buyers looking to avoid taxes.