Mar122014

Republican tax reform proposal curtails homeownership subsidies

Republican tax reform proposal lowers marginal rates by eliminating nearly all home ownership subsidies.

housing_consumerI recently wrote that potential home ownership subsidy changes would flatten Coastal California house prices because our housing markets are directly supported by a combination of all these subsidies. Reducing or eliminating them would make owning a home much more expensive and thereby much less desirable. There’s no question home ownership subsidies inflate house prices, and there’s mounting evidence it does little to increase home ownership rates or improve communities. Given the high cost to the government, $121 billion in 2013 alone, it’s a costly subsidy with dubious benefit — a perfect target for tax reform.

Tax reform proposal would cut many real estate deductions

Many long-standing home real estate tax benefits would be eliminated or sharply reduced under Rep. Dave Camp’s tax overhaul plan.

WASHINGTON — You may have seen reports about a major tax reform proposal floated recently by Rep. Dave Camp of Michigan, the chairman of the House Ways and Means Committee. …

This is no back-of-the-napkin set of proposals. Camp and his committee — the primary tax-writing panel in Congress — have been working on this for two years. They’ve held extensive public hearings and done significant research.

This has been a long time coming, and his work will be taken very seriously by Congress. It may not get passed, or it may get amended beyond recognition, but it will serve as a starting point for a vigorous debate.conehead

•  Though Camp’s reform package has zero chance of enactment in an election year, many of its core concepts are likely to reappear on Capitol Hill as early as 2015, when new chairmen at both Ways and Means and the Senate Finance Committee take up fundamental tax reform.

Unfortunately, this is true. We will have to wait another year or two before we have greater certainty about the impact of tax subsidies on real estate.

•  Even the most die-hard proponents of real estate tax benefits concede that with the right combination of lower federal income tax brackets and higher standard-deduction levels, housing’s special carve-outs in the tax code would be less compelling to many homeowners. Why itemize when you can just take the standard deduction and save more? Once this sinks in, the political support for retention of owners’ unique tax privileges in the code will begin to crumble.

The simplest way to eliminate deductions is to reduce their value. Raising the standard deduction makes itemizing more expensive because the taxpayer must give up the standard deduction, and lowering rates directly lowers the value of deductions. If Congress also lowers caps and phase outs, they can all but eliminate any advantage to itemizing. Once that’s done, they can effectively eliminate tax deductions without taking the political heat from the various constituencies who enjoy the subsidies.HELOC_hog

So what did Camp propose? For the vast majority of individuals and corporations, enticingly lower marginal rates of 10% and 25%, plus a substantially increased personal standard deduction — $22,000 for married joint filers, $11,000 for singles. Individuals with annual incomes above $400,000 and joint filers above $450,000 would pay taxes at a marginal rate of 35%.

Ronald Regan would have loved this idea. It takes Congressional manipulation of tax incentives out of the equation and puts more money into the pockets of individuals to spend as they please.

In exchange, say bye-bye to the mortgage interest deduction in its current form. The $1-million limit on mortgage amounts that qualify for interest deductions would phase down to $500,000 in four annual steps, with no indexing to inflation. This would effectively diminish its value year after year as inflation takes its bites.

That’s a great first step, unless you live in Coastal California and have a mortgage between $500,000 and $1,000,000, then you aren’t so plussed by the idea.

The good news on interest deductions: Anyone with an existing mortgage of $500,000 or higher on the date the tax bill takes effect would be grandfathered for the life of the loan.

Well, that preserves the value of the deduction for the current borrower, but since the future buyer (and borrower) won’t be able to gain the advantage of this deduction, they won’t be incetivized to leverage themselves so much. This will impact the future resales price of the property, and it will not be higher as a result of the change. I also assume this grandfathering only applies to existing loans and not to Ponzi refinances later on.house_cat_HELOC_abuse

The bad news: Interest write-offs on home equity borrowings, currently limited to $100,000, would be prohibited unless the money was being used to improve your property.

That’s the best news of the whole proposal. People should not be able to roll their non-deductible consumer debt from credit cards and other sources into long-term, deductible mortgage debt. This merely encourages Ponzi borrowing and foolish financial management.

Another set of changes Camp would make: He’d revise the present $500,000 and $250,000 capital gains exclusions for profits on sales of homes by joint filers and single filers, respectively. Under today’s rules, you can claim a tax-free exclusion once you’ve owned and lived in a home for two years out of the preceding five years and you can do so once every two years.

Under Camp’s proposal, you’d need to own your house for five out of the preceding eight years to claim a tax-free exclusion and you could exercise this privilege only once every five years. Capital gains exclusions for home sellers with high incomes — $250,000 a year for singles and $500,000 a year for joint filers — would be phased out altogether over a period of years.

That’s another great change. As it currently stands, the capital gains exemption encourages short-term ownership, particularly in Coastal California where house prices may go up more than $500,000 in a short period of time. Long-term capital gains are supposed to benefit long-term homeowners, and his redefinition of long-term home ownership is a good change.kick_the_house

Besides these, Camp’s tax bill would:

•End all deductions for local property taxes, which he considers subsidies for excessive spending at the local government level.

This won’t hurt California as much as it will hurt states where property taxes are very high, particularly in the Northeast.

•Eliminate credits for owners who make energy-saving improvements to their homes.

This is a good deduction, IMO, but we have to lose some good ones to eliminate the bad ones.

•End penalty-free withdrawals from IRAs to help fund first-time home purchases.

This will make it harder to save for a down payment because it will have to be after-tax income, but it will help people build their retirement nest egg.

•Leave in limbo popular mortgage debt forgiveness tax benefits used by large numbers of short-sellers and foreclosed owners in the last several years. Camp’s plan is silent on extending the benefits — which are currently expired, awaiting extension — but in this case silence would be fatal.

•Kill federal tax exemptions for state and municipal bond programs used to fund mortgages for moderate-income families.

This will hurt some families, but it will also stop the inflation of house prices which priced many of these families out to begin with.

Bottom line: Though preliminary action on tax reform is at least a year away, homeowners need to grasp a sobering, emerging reality: To pay for a streamlining of the ballooning federal tax code and provide lower rates on income, there’s a chance that Congress will demand that you give up long-entrenched tax subsidies that have put homeownership on a pedestal, supported prices and sweetened the household finances of millions of Americans for decades.

Whoa. Didn’t we all assume that homeownership is politically sacrosanct? Right, but when the chief Republican tax writer in Congress proposes throwing out most of those perks, you’ve got to reexamine that assumption.

I think these would all be good changes.

Do you think tax reform will pass?

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