Holding off the Glut from `Trading Down' the Capital-Gains Tax, Though Painful for Individual Home Sellers Whose House Values Have Soared, May Be Preventing the Collapse of the Urban Real-Estate Market

Article excerpt

A GROWING anxiety has gripped urban and suburban America. A fraying social fabric - evidenced by gang violence, hour-long commutes on endless freeways, and the environmental degradation of the nation's large metropolitan centers - is kindling a new wave of migration.

If current homeowners can afford to escape, the coming flight from suburbia will have enormous economic impact far beyond the temporary effects of the current recession. But middle-class homeowners are boxed in by the curious logic of speculation and the tax code.

Throughout the speculative 1970s and 1980s, California was the peerless paradise for players of the real estate trade-up game. The median California home price had appreciated from $23,100 in 1968 to a whopping $194,010 in 1990, the peak year - an increase of more than 800 percent. Homeowners enjoyed similar gains in the Northeast. But in 1992, the outlook is radically different.

Consider the situation of a Los Angeles couple I know. In 1971 they began their climb to suburban affluence by purchasing a modest home for $38,000. Rapidly rising property values allowed them steadily to trade up to more spacious residences. By 1990 they had parlayed their initial investment into $475,000, the peak value of their present home.

My friends would love to cash out, purchase another house in a more remote and more satisfying location, then invest the remainder of their profits to pay off long-accumulating debts. In fact, they've made a small down payment on an idyllic lot in Washington state as a first step toward their eventual escape to fresh air.

Trouble is, they can't afford to sell. After taking all allowable deductions, and after buying a less expensive house, their total taxable gain would come to over $150,000, requiring a tax payment of at least $45,000 - in cash. That's money they don't have. Like too many Americans, they borrowed against the prospective gains tied up in their home and spent the proceeds on great vacations in Europe, fancy parties, new cars. The good life. They thought the music would go on forever.

But the tune has changed. The precipitous fall of California real- estate values since 1990 cut the value of my friends' house from $475,000 to $380,000. They "lost" $95,000 in capital appreciation. If that mini-crash hadn't occurred, they would have paid $28,500 in additional taxes on the lost appreciation, but $66,500 of it would have been left over. …

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