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The Housing and Economic Recovery Act of 2008 was recently passed into law with a lot of positives for the American People. To take effect in January 1 2009, the law provides some of the most radical steps taken to help the average American home owners. Some of the highlights include up to 7500 in purchase credits for first time home buyers, conforming loan limit increases to 625,000 in high cost areas, expansion of the FHA to save delinquent homeowners, and funds earmarked for local government to buy and restore blighted homes and neighborhoods. But the law is like sugar coated poison for some homeowners and it is not covered by the main media stream. Deep in the 694 page law, on page 690, there has been a new important change to the Capital Gains Exclusion rule.

According to basic definitions, Capital Gains Tax is a tax placed on the profits from the sale of real estate or investments. Now the Capital Gains Exclusion Rule, as per the IRS, home owners can claim up to $250,000 or $500,000, if filed jointly, tax-free provided that they have lived there for at least 2 years of the previous 5 years. However, the new rule radically changes this exclusion with a new set of formula. Before you panic, this law does not apply to homeowners who have lived in their primary residence and have not rented it out. The loss of the $250,000/$500,000 Capital Gains Exclusion applies to properties that have been used as both a primary home and as a rental property only.

In order to make tax-free profits, homeowners used to switch their residence between their homes every 2 years to gain the Capital Gains Exclusion. Such behavior is useless now as homeowners are now faced with a certain formula when selling their homes.

The Capital gains Exclusion is now calculated by the profit from the sale of your home times the number of days the home was your primary resident divided by the number of days the home was owned.

So your Capital Exclusion = Profit x Primary Days/Days the home was owned. Thus is a home owner lived in the house for 2 years and the house was rented for the next 3 years, when he sells the house, only 40% of his profits are considered tax-free while the rest is taxed under the Capital Gains Tax. Before this new law came into effect, the homeowner got 100% of his sale as profit tax-free.

So what is the big deal? Well now American homeowners can no longer expect to get the money they are selling their homes for. Currently, Capital Gains Tax is at 15% so whatever profits you earned that is not covered under the Exclusion rule is now taxable. So you are loosing 15% of your profit from the sale of your home to taxes. But 15% is not so bad for now, but if the Capital Gains Tax is to change, then the home owners are in real trouble. In the past, it was well known for the capital tax to be even as high as 45%. Such a figure can be devastating to the homeowners in an already troubled real estate market. This puts more burdens on the average homeowner while the more financially capable individuals make more profit from this bill's hidden clause.

Learn more about this author, Ebey Soman.
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