Monday, December 17, 2012

The Fiscal Cliff, Healthcare, Housing and You

As we near the end of 2012 and the edge of the fiscal cliff, as usual the big debate is whether the Bush tax cuts should be extended or allowed to expire, and if they should be extended, for whom. As liberals and conservatives debate the impact on the economy, the focus of the media's coverage of the debate seems to focus mainly on the increases to the top income tax rate. After a two year reprieve on these extensions, most Americans seem to now believe that it is best to let the tax cuts expire for the top earners while ensuring that they are maintained for everyone else.

I think that framing the Bush tax cuts debate only in terms of income tax increases really minimizes the full effect of allowing the tax cuts to expire. Remember that the tax cuts did more than just lower the income tax rate; they also gave a hefty shot in the arm to the real estate market.

Under the Bush tax cuts, an individual could sell his or her primary residence and realize up to a $250,000 gain tax free. A couple could sell their primary residence and realize up to a $500,000 gain tax free. And this gain did not have to be reinvested in a new primary residence to reap the tax advantages; the sellers could choose just to put the money from the sale in an investment account and rent for the rest of their lives. The capital gains tax holiday gave a powerful boost to the real estate market because it allowed Americans to purchase a home and benefit in a very direct way from their properties' appreciation.

If all of the tax cuts are allowed to expire, next year the sales of primary residences will again be subject to capital gains tax. (Presumably the tax will revert back to the prior law before the tax cuts where no capital gains is owed if a new primary residence of equal or greater value is purchased within a set period of time.) But what if the tax cuts are extended to the middle class and only allowed to expire for taxpayers with incomes of $250,000 a year or more? What effect will that have on the housing market?

Remember that for the past couple of years Fannie Mae and Freddie Mac's average borrower today has a credit score of 751 and a down payment of more than 30%. That means essentially that these two agencies, both of which have received hundreds of billions in tax dollar bailouts, are basically making loans to upper middle class borrowers--the ones who typically have higher incomes. A capital gains' tax on primary residences, combined with higher income taxes and a looming threat to discontinue the tax deduction for mortgage interest, may discourage these borrowers from investing in real estate. At the very minimum, it is going to discourage them from buying higher priced homes. Discouraging the very borrowers who are in the best position financially to purchase homes and pay the mortgages on them can only result in a further slowdown of the real estate market, and potentially greater declines in housing prices. Many of the taxpayers in the $250,000 bracket are actually small business owners. With increasing economic problems, and dropping market values, how comfortable are they going to feel going through the pain of purchasing a home knowing upon sale the gain will be subject to taxes because they earn over $250,000 a year?

I know that it can be argued that for many years primary residences were subject to capital gains tax upon sale, and that the tax did not stop people from buying or selling property. But I would counter that there is a strange phenomenon that comes into play when people are used to getting something (in this case a capital gains' tax holiday on their primary residence) and then see it taken away. We saw this with the home buyer tax credit. Buyers had bought and sold houses without an $8,000 tax credit since the beginning of civilization, but in the short time that it was implemented, buyers came to believe that they should expect a tax credit. Consequently, when the tax credit expired, buyers largely stopped putting in contracts on houses. The credit should not have provided all that much incentive--after all, the primary reward for purchasing a home is having a place to live--but once the inducement was offered and then removed, borrowers did not seem to see the point of buying a home for which they would not receive a tax credit.

Two years ago the tax cuts were extended for everyone. Now President Obama is adamant that they should be extended only for those earning less than $250,000. But this plan poses an additional set of challenges. The new health care law signed in March also contains a tax on real estate. The 3.8% tax on the sale of residential real estate applies to individuals with incomes higher than $200,000 and couples with combined incomes over $250,000. On a sale of a $300,000 home, the tax would be $11,400.00. This would be in additional to the capital gains tax. And since the health care tax is on the sales price and not on the gain, it would apply to any borrower in the income bracket being taxed. In other words, if you sell your house for enough to cover what you owe the bank plus the agent's commission and your costs as seller, you could still owe Uncle Sam a check.

We like to think that "rich" people, whom we as a society have defined as people with incomes over $200,000 or $250,000, have so much money that they don't feel these taxes at all and that any complaining that they do is only a result of greedy whining. But at what point do the more affluent people in our society decide that real estate is too heavily taxed and that they are better off renting rather buying? At what point do current homeowners who do have extra cash decide to offer their homes for rent rather than for sale because they are rebelling against a plethora of taxes which gobble up their equity? And what are the consequences of this shift in thinking for an already lethargic housing market?

In spite of reports that I have been reading all year, I personally have not seen a housing market recovery or improved housing prices. With one exception, none of the appraisals I ordered this year came in as well as expected. Properties that were purchased last year at lower than expected prices appraised this year for less than last year's purchase price. In my conversations with underwriters in other areas of the state, I have learned that this continued depreciation of the housing market is actually typical right now. Do we want to make a declining housing market worse than it already is by disincentivizing still more borrowers?

Raising taxes--even for the top income brackets--may generate a lot of money for the U.S. Treasury in the short term, but in the long term it will lead to increased unemployment which will lead to increased mortgage defaults and delinquencies at a cost to lenders, Fannie Mae, Freddie Mac, and ultimately the American taxpayers. Taxing the life out of what is left of the housing industry is really just cooking and eating the goose that laid the golden egg.

Alexandra Swann is the author of No Regrets: How Homeschooling Earned me a Master's Degree at Age Sixteen and several other books. Her novel, The Planner, about an out of control, environmentally-driven federal government implementing Agenda 21, is available on Kindle and in paperback. For more information, visit her website at

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