IN TAX LEGISLATION (H.R. 2014) SIGNED INTO LAW

AUGUST 5, 1997

H.R. 2014

CAPITAL GAINS REDUCTIONS AND DEPRECIATION RECAPTURE

Capital Gains tax rate reduced from 28% to 20% (10% in 15% bracket)

Effective for sales or exchanges on or after May 7, 1997.

Holding period for all assets increased from one year to 18 months.

Effective for sales or exchanges after July 28, 1997. Transition rules provided for property sold after that date, but held for less than 18 months but more than 12 months.

Depreciation recapture tax rate 25%.

Effective on or after May 7, 1997.

Special rules to become effective after December 31, 2000, providing 18% capital gains rate (8% in 15% bracket) for assets held 5 years or more. In order to qualify for the 18% rate for property held before January 1, 2001, taxpayers must satisfy complex rules. No property sold before January 1, 2006 will qualify for the 18% rate.

The alternative minimum tax (AMT) will not apply to capital gains benefits.

No provision for indexing asset basis for measurement of gain.

$500,000 EXCLUSION ON SALE OF PRINCIPAL RESIDENCE

Couples filing a joint tax return can exclude up to $500,000 of gain on sale of principal residence. Single return filers can exclude up to $250,000.

Gain in excess of $500,000/$250,000 taxable at capital gains rate.

Effective for sales on or after May 7, 1997.

Home must be used as a principal residence for two of the preceding 5 years.

Exclusion does not apply to vacation or second home properties. Formula provided to give partial exclusion to those who cannot satisfy the two-year requirement.

Provision replaces and improves rollover and $125,000 exclusion rules.

Age 55 requirement eliminated. Provision available to homeowners of any age.

No requirement to roll over proceeds and reinvest. Thus, homeowners have options to trade up or trade down on a tax-free basis.

If a home is used as a principal residence and as a rental property during the period of ownership, any depreciation taken after May 7, 1997 must be recognized on sale.

SECTION 1031 LIKE-KIND EXCHANGE

No change to current law for real estate.

HEALTH INSURANCE PREMIUMS FOR SELF-EMPLOYED

Self-employed individuals will be permitted to deduct their health insurance premiums based on the following phase-in schedule:

• 1997 40%
• 1998, 1999 45%
• 2000, 2001 50%
• 2002 60%
• 2003 - 2005 80%
• 2006 90%
• 2007 100%

HOME OFFICE DEDUCTIONS

Rules for deductions of home office expense are clarified so that individuals who work exclusively from home will be permitted to take deductions for their home office if they perform administrative and managerial tasks in the office, but perform the actual services that generate income outside the office.

Effective January 1, 1999.

PENALTY-FREE WITHDRAWAL FROM INDIVIDUAL RETIREMENT ACCOUNTS (IRAs)

New law allows penalty-free withdrawal from IRAs for first time home buyers, up to $10,000.

Withdrawals can be made from current IRAs, beginning January 1, 1998.

A first-time home buyer is an individual (and his/her spouse) who has had no ownership interest in a home during the previous 2 years.

The first time home buyer must use the distribution from the IRA before the close of the 120th day from the day the payment is received to pay qualified acquisition costs for a principal residence.

IRA withdrawals from spouses, parents, children, grandchildren or ancestors are all eligible, but can total no more than $10,000.

Withdrawals from the new “Roth IRA” can be made both tax-free and penalty-free if the account is held 5 years. Even though these new “Roth IRAs” can be created starting in 1998, the tax-free withdrawal feature will not be in effect until after 2002.

BROWNFIELDS, ENVIRONMENTAL REMEDIATION EXPENSES

Taxpayers will be permitted to deduct, rather than capitalize, environmental cleanup costs for hazardous substances in specified target areas.

No deduction for acquisition costs.

Targeted areas will generally consist of locations where the poverty rate is very high. State agencies will designate and certify qualified locations.

Expenditures will be subject to ordinary income recapture at time of sale. Applies to expenditures incurred between August 5, 1997 and January 1, 2001.

ESTATE TAX RELIEF

The unified estate and gift tax credit of $600,000 for an estate was increased to $1 million.

Increase phased in over ten years.

• $625,000 1998
• $650,000 1999
• $675,000 2000, 2001
• $700,000 2002, 2003
• $850,000 2004
• $950,000 2005
• $1 million 2006

Exclusion created for up to $1.3 million of value in “qualified family-owned business interest” from a decedent’s taxable estate, if the interests comprise more than 50% of the decedent’s estate and if other requirements are met.

A qualified family-owned business is any interest in a trade or business if ownership is held at least 50% by one family, 70% by two families, 90% by three families, as long as the decedents family owns at least 30% of the trade or business.

Both the original owners and the heirs must materially participate in the business for specified time periods.

The increased exemption amount and the family business exemptions can be used together, but the total exemption cannot exceed $1.3 million.