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Bush's housing proposals have their down side

If you interpreted President Bush's State of the Union message as strongly favorable to real estate, you missed the fine print.

A close look at the mechanics of the proposals reveals far less relief than the rhetoric suggested. And in at least one key area _ capital gains _ the proposals represent a tax increase for many real estate owners, not the ballyhooed tax cut.

Here's what the administration's fiscal 1993 budget would really mean:

Capital gains. When the president promised to fight for a maximum 15.4 percent capital gains rate for assets owned for three years or more, that sounded like a major financial boon for owners of homes, rental properties and most forms of investment real estate. Under current federal law, such owners pay taxes on up to 28 percent of their gains from sales. Under the plan, they'd get to slice that tax exposure nearly in half.

But tucked away in the budget is a little hand-grenade called "recapture of depreciation." What it means for real estate owners is this: Any depreciation write-offs you've taken during the course of your ownership will be taxed at your full rate when you sell your property.

Say you have $50,000 in resale profits on a small rental duplex you bought years ago, and you took $45,000 in depreciation during your period of ownership. At first glance, the president's proposed 15.4 percent capital gains rate looks far better than the current 28 percent. But the recapture requirement would alter that drastically. Only $5,000 of your profits would be taxed at the 15.4 bargain rate; the other $45,000 would get hit with the ordinary personal income tax rate, which may well be 31 percent. Under current law your federal tax bill on the transaction would come to $14,000 ($50,000 x .28). Under the new plan you'd pay $13,950 for depreciation recapture ($45,000 x .31) plus $770 ($5,000 x .154) for a total of $14,720. The bite would be even deeper if congressional Democrats successfully push the top federal tax bracket to 35 percent as the quid pro quo for their capital gains compromise.

"Passive loss" tax relief. The president endorsed the concept of loosening up the controversial passive-loss system that has severely restricted write-offs on most rental real estate since the 1986 Tax Reform Act. Some property owners who heard his speech may have assumed the president was lining up behind legislation already cosponsored by 322 House members and 40 senators. Those bills (H.R. 1414 and S. 1257) would allow taxpayers who are actively "engaged in the real property business" to offset losses on their rental activities against income from other, non-rental sources. To qualify for relief, they'd have to spend at least 50 percent of their working time and no less than 500 hours a year on rental property activity. Large numbers of property owners _ small-scale as well as large _ could pass this standard, according to real estate experts.

But the president's budget stopped far short. It would limit passive-loss relief to "developers" who "actively participate" in the rental of properties. Virtually all individuals who acquire rental property developed by someone else, or who don't pass stringent "material participation" tests, would be excluded.

IRA down payment withdrawals. The Bush budget would allow first-time buyers to escape the usual 10 percent early withdrawal penalty if they pull up to $10,000 from their Individual Retirement Accounts for a down payment. But they'd still have to pay regular federal and state income taxes on their withdrawals _ a price heavy enough to discourage young, thinly capitalized taxpayers from using this option. By contrast, legislation sponsored by Senate Finance Committee Chairman Lloyd Bentsen, D-Texas, and Sen. William Roth, R-Del., joined by more than 70 co-sponsors, would allow parents and grandparents to tap their IRAs penalty-free to provide down payment funds.

The $5,000 tax credit for first-time buyers. Though a genuine stimulant to home building and buying, it doesn't solve the main problem faced by first-time buyers: How to come up with the down payment and closing costs. Among the ideas being explored on Capitol Hillare proposals allowing builders to loan down payment money to buyers, with the $5,000 credit as partial collateral.

Washington Post Writers Group