Housing Prices May Get Doused by U.S. Tax Revision: John Wasik
Housing Prices May Get Doused by U.S. Tax Revision: John Wasik
Oct. 17 (Bloomberg) -- To make the U.S. tax code fairer and cut the dreaded Alternative Minimum Tax, Congress may end up putting a damper on the housing boom.
President George W. Bush's Advisory Panel on Tax Reform will issue its final report by Nov. 1, and it's possible that tax deductions for housing may be pared. If passed by Congress, such a proposal would raise the after-tax cost of a home and reduce prices in the hottest markets.
Homeowners aren't even the main target of the review. While taking a look at the AMT, which the panel decided was a top priority for elimination, lawmakers may end up reconsidering tax breaks for housing.
The AMT denies most large itemized deductions and raises total federal tax bills. Small wonder it has little popular support. Because one of the panel's mandates is to offer ``revenue neutral'' solutions that don't add to the federal deficit, the panel must find ways of replacing the tax's contribution to the Treasury.
Since Congress neglected to index the AMT for inflation, some 40 million mostly middle-class Americans in states with the highest costs of living -- largely on the coasts -- are expected to get clobbered by it by 2010.
Fiscal Hole
The loss of the AMT would leave a huge fiscal hole. The tax is forecast to bring in $600 billion to $1.2 trillion during the next decade.
``How do we pay for it?'' said John Breaux, former Democratic Senator from Louisiana and vice chairman of the panel. ``It always brings up difficult choices.''
The president's tax panel is discussing capping the mortgage interest deduction at $350,000, limiting interest write-offs to 25 percent of income, or adding a tax credit for mortgage interest so that all taxpayers would receive the same deduction. Trimming write-offs for company health insurance and local property taxes are also being considered.
The panel's intent is to ensure that lower- and middle- income homeowners get the same tax benefit as high-income taxpayers. As it stands now, the bigger your mortgage and property-tax bill, the greater your tax break. The top 2 percent of tax filers, most of whom itemize, receive 22 percent of the benefits from the mortgage-interest deduction.
Real Estate Breaks
Real-estate tax breaks are a huge subsidy for one of the most vibrant sectors of the U.S. economy.
At present, you can deduct interest on up to a $1 million mortgage and property taxes up to the top marginal rate of 35 percent. Most married couples also pay no tax on a home sale if gains are under $500,000.
This triple dip costs the U.S. Treasury about $110 billion a year. You can reap even more tax plums if you are an investor; then you can write off the operating and repair expenses of your rental properties and exchange similar real estate without paying capital gains.
If the tax panel's proposal to curtail mortgage deductions becomes law, there would be ``an increase in financing costs and a decline in prices, particularly at the high end,'' said Doug Duncan, chief economist for the Mortgage Bankers Association, a Washington-based industry group. According to Duncan, that would largely affect homes priced at more than $438,000.
Subsidies Crucial
What if you couldn't write off up to 35 percent of property taxes, another item considered for paring by the panel?
Yale economist Robert Shiller, the author of ``Irrational Exuberance,'' and others have argued that the U.S., particularly on the coasts, is in the midst of a speculative bubble in home prices. If you subscribe to the idea that home subsidies are contributing to overheated housing prices, then trimming those breaks would raise the total cost of homeownership and hit the priciest markets the hardest.
Is it fair to say that the properties with the highest levels of debt and taxes might decline in value by one-third? No one knows for sure, yet home buyers in high-tax states like California, Massachusetts, New Jersey and New York would certainly hesitate before trading up or building more-expensive homes.
``Let's pretend this happens,'' said Mike Dubis, a financial planner with Touchstone Financial LLC, in Madison, Wisconsin. ``People with high income and no assets will get hurt.''
Limited Effect
Another school of thought says the shock may be muted by transition rules that would grandfather the older, more generous tax breaks for existing homeowners.
``There would be a relatively small set of first-time buyers who would choose not to buy,'' says Dick Lepre, senior loan consultant for Residential Pacific Mortgage in San Francisco, which writes $2.7 billion in mortgages annually. ``A bubble buster? I think not. A moderating force? Sure, and a most welcomed one. The most affected places will be those cities and towns with $800,000 to $2 million homes with cachet.''
The combined lobbying of the real estate, banking and home construction industries may ensure that home deductions remain, regardless of the panel's recommendations to Congress.
And with mid-term elections looming next year and President Bush's political capital running low, these proposals may never make it off the pages of the panel's report.
Nevertheless, the panel's ideas need to be reviewed, if for no other reason than to study tax fairness and its impact on a housing market that is becoming inflated -- and more nervous.
To contact the writer of this column: John F. Wasik in Chicago at jwasik@bloomberg.net;
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