John M. Lee: Effects of New Real Estate Law

President George Bush signed the Jobs and Growth Tax Relief Act of 2003 into law on May 29, which includes some features that are retroactive to the beginning of the year or to the "mark-up" dates for the law on May 6. As all changes in the tax code go, it is rather complicated and affects each individual in its own way.

I can speak from personal experience. When I completed graduate school in the summer of 1986, I was all set to start my career in commercial real estate. However, with the passage of the Tax Reform Act of 1986 (which took away all the tax benefits of owning commercial and investment real estate), I had to re-evaluate where to take my real estate career and finally decided on residential real estate rather than commercial, which, as it turned out, has been the best career decision I ever made.

This latest legislation has some major implications for investments in stocks, bonds and mutual funds; it has very little effect on real estate transactions. The tax benefits allowed for real estate investors remain just as compelling as they were before this law was passed. This is especially so for owners of personal residences who can and should approach their homes as the core investment in their lives, especially in San Francisco.

Even though the changes in the 2003 tax law are not dramatic for real estate, nevertheless, they are complex and I urge you to seek the advice of a tax advisor if you have any specific questions. This column will provide you with some information and fortify you with some questions you may want to explore further with your accountant, CPA or tax advisor.

The most significant non-change is that Bush and Congress left the $500,000 ($250,000 if single) exemption alone. Thus we still get to exclude up to $500,000 (or $250,000 if single) in adjusted gains from taxation when a principal residence that has been lived in two out of the past five years. Any gains above that amount are taxable as capital gains and will be taxed at the new lower capital gains rate.

For investment real estate, all the tax-deferred exchange rules remain the same. You can still exchange any type of real estate for another type, such as raw land for a shopping center, or an apartment building for a single family home (as a rental). The time periods for identifying property remains at 45 days and closing at 180 days.

If it's a straight sale though, the capital gains will be taxed at the lower tax rate of 15 percent maximum, but the gains attributable to previous depreciation will be subject to tax at a rate of 25 percent. The exception is if the gains are "minor in amount and your income places you in a lower bracket" - then the lower bracket will apply.

Even though real estate isn't particularly affected for better or worse by this particular tax act, real estate is likely to remain the investment of choice for millions of Americans. Personal residences still get the best tax treatment of just about any possible investment. No other investment can offer up to $500,000 in gains without any capital gains taxation. Meanwhile, investment residential real estate continues to benefit from its flexibility. You can sell, exchange and even move-in and stay for two years and then qualify the home as a personal residence, most likely eventually paying no taxes at all on the gains from the home's sale.

As we start on our Fall selling season, I would urge you to examine your real estate portfolio and determine how you want to position yourself for the future. Interest rates have been inching up and I doubt that we will see mortgage rates like we saw two months ago. However, from a historic standpoint, we still have some of the best rates available. So if you have not refinanced your loan yet, it might be a great time to do so. If you are contemplating selling, now would be a great time to act; otherwise the holiday season will be upon us before you know it.

John M. Lee has an MBA from UCLA and specializes in the Richmond and Sunset districts. For questions concerning real estate, call him at (415) 447-6231 or e-mail hin at johnlee@isellsf.com.