Question

5. Prior to 1997, many university professors who moved from expensive places like Boston or San Francisco to low-cost cities like Madison, Wisconsin, or Gainesville, Florida, tended to purchase extremely large houses upon their moves. This tendency was dramatically curtailed after 1997. What feature of the U.S. tax code encouraged this behavior? (Hint: this was briefly mentioned in class, but you may need to read the textbook.)

Answer 1

TRA97 made the tax treatment of home capital gains considerably simple. Before 1997, a house seller was subject to capital gains tax if the selling price net of selling expenditures exceeded the adjusted basis of the house. The adjusted basis is described as purchase price along with purchase costs ( settlement fares & closing costs) & the cost of enhancements & additions. However, if the house seller purchased a replacement accommodation of equivalent/ higher worth within a 4-year window, she would defer the capital gains taxes till the next time she sells her house. If the replacement accommodation worth was between the purchasing price & the selling price of the present house, the differential between the replacement house worth & the selling price of the current house would lead to immediate taxes, & the differential between the replacement house worth & the purchasing price of the present house would be postponed. The sum of deferred capital gains would be deducted from the basis of the newly bought replacement house. This tax stipulation, unofficially called the ‘roll-over regulation,’ had been in the IRC since 1951.showed that the roll-over regulation generated ‘kinks’ in house sellers’ budgetary sets & encouraged persons to consume more lodging than they otherwise would’ve.

Besides the roll-over regulation, the IRC also featured preferential tax treatment for elderly house sellers before TRA97. Since 1964, house owners aged 65 & over who had lived in their houses for at least 5 out of the last 8 years were entitled to a once-in-a-lifetime exclusion of up to twenty thousand dollars against taxable capital gains. The maximum exclusion sum was raised to 35,000 dollars in 1976. In 1978, the age requisite was lowered to fifty five, the residence requisite was changed from living in the house for at least 5 out of past 8 years to 3 out of previous 5 years, and the maximum exemption sum was raised to 100,000 dollars.

TRA97 became law on 5^th August, 1997. It fundamentally modified the tax treatment of home capital gains. Firstly, TRA97 eradicated the roll-over regulation. Secondly, it eradicated the age-55 regulation. Thirdly, it permitted house sellers to exclude home capital gains of 500,000 dollars (or 250,000 dollars for single filers) if they’ve owned & lived in their accommodations for at least 2 years of the past 5 years. There’s no limit on how many times a person can claim such exclusions during his lifetime. Lastly, TRA97 lowered the topmost tax rates on long run capital gains .