Real estate driven tax changes

I wasn't really paying attention to this before, but I've seen quite a few stories on the Housing Assistance Tax Act of 2008 over the last week. (The about.com story gives better examples.)

A few things the new law encompasses

• First-time homebuyer credit of up to $7,500
• Property tax deduction even if you don't itemize
• Better tax credits for low-income housing and renovating old buildings
• More relief for 2005 hurricane victims
• Changes in capital gains exclusion for real estate
• Reporting of credit and debit card payments

Being a law written by our Congress, there are of course other provisions in it (why can't our laws ever be simple changes?). I'm interested in the first-time homebuyer credit and the changes in the capital gains exclusion for real estate.

First-time homebuyer credit

The first-time homebuyer credit is a credit up to $7,500. The 'credit' has to be repaid though over 15 years. And there is an income limit of $95,000 for individuals and $170,000 for married couples filing jointly, so those in the mass affluent segment may not qualify due to income.

Changes in capital gain exclusion for real estate

Previously, the tax laws allowed a homeowner to exclude up to $250,000 in gains (or $500,000 for joint filers) as long as the homeowner owned and lived in the house for at least two years out of the five years ending on the date of sale. Now, any gains will need to be allocated based on usage. Only gains allocated to time spent living in the property as a primary residence will qualify for the tax exclusion

OK, an example really helps to understand this.

Here's an example: Suppose a married couple buys a home on Jan. 1 next year for $600,000, says Mr. Olivieri of White & Case. They plan to hold it as an investment. On Jan. 1, 2012 -- three years later -- they begin using it as their principal residence. They live there two years and sell it on Jan. 1, 2014 for $1.1 million, for a profit of $500,000.

Under the old law, they would have been able to exclude the entire $500,000 gain from their taxable income, Mr. Olivieri says. But under the new law, they could exclude only two-fifths of the gain, or $200,000, since the other three-fifths would be considered attributable to the three years the home wasn't their principal residence, he says.