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Bill Tightens Second-Home Tax Rules

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By John Godfrey, The Wall Street Journal

RISMEDIA, Oct. 1, 2007-(MarketWatch)-Popular legislation to ease the tax burden on struggling homeowners could hit an unexpected constituency: people with second homes. The Ways and Means Committee, the House’s tax-writing panel, approved a bill last week under which homeowners facing foreclosure won’t get stuck with a tax bill if part of their debt is forgiven by lenders. Currently, forgiven debt is treated as income to the borrower and is subject to tax.

The committee decided to pay for the tax break, as required by congressional budget rules, by restricting homeowners’ ability to avoid or reduce the taxes on the sale of second homes. The gain in revenue would be equal to roughly $2 billion over 10 years.

Some Republicans complained that the move would hurt the second-home market. Rep. Kevin Brady (R., Texas) said the change would punish those who had saved to purchase a second home. Rep. Sam Johnson (R., Texas) called it a “luxury tax on retirement homes.”

There is little evidence that such opposition could threaten the underlying bill. The bill, which came in response to the subprime-lending crisis, has broad bipartisan support in both the House and Senate. The Senate hasn’t said how it would pay for the bill.

Treasury tax counsel Michael Desmond said that while the Bush administration differed with the bill on several fronts, it supported the committee’s vote. A White House proposal would shield homeowners from the debt-forgiveness tax for three years. The House bill makes that change permanent.

Industry groups, such as the Mortgage Bankers Association and the National Association of Realtors, weren’t thrilled at the tighter tax rules for second homes but still supported the overall bill. “No one likes to be the pay-for,” said Linda Goold, tax counsel at the Realtors’ group. But, she added, “a tax benefit has been curtailed, but nothing has been eliminated.”

Under current law, a person can exclude from taxes up to $250,000 in capital gains on the sale of a principal residence. Up to $500,000 of gains can be excluded for married couples. A second home can become a principal residence as long as the taxpayer has lived there for two of the previous five years. The bill approved [last week] would change those rules. Under it, the size of the tax break for a second home would be tied to the portion of time, out of all the years a house is owned, that it serves as a principal residence. Living in a property longer would result in a larger tax break on any gains when it is sold.

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