As of this evening (Monday), it seems that the Senate version of the housing bill will make it intact to the vote on tomorrow. And you know that I’m not a fan. I promised that I’d explain why I think it’s a bad idea. It’s taken a few extra days (yes, a plague of biblical proportions seems to have fallen on my house) but here goes…

The original bill, as passed in the fall, was a $7,500 federal income tax credit for “first time homebuyers” that had to be repaid over 15 years. In that way, it was like an interest free loan. Phaseouts apply for single taxpayers at $75,000 and married taxpayers at $150,000.

The second version of the bill, which was not made law but passed in the House, was to revoke the repayment requirement, and offer a straight $7,500 federal income tax credit for “first time homebuyer.”

The final (?) version of the bill, which is not yet law, is a $15,000 federal income tax credit with no repayment requirement. A key difference in this final version from the House version is that this credit is nonrefundable, meaning you can only receive the credit if owe federal income tax; the Senate bill would also allow taxpayers to tax the credit over a period of two years. The Senate version of the bill is not limited to “first time homebuyers” and will be effective as of the date the bill is signed into law. It would not be retroactive and it would last for one year. A repayment requirement would apply if the home is sold within two years.

Whew. So much wrong, I almost don’t know where to begin.

Let’s start with the obvious: who is buying these homes? You would think, from all of the incentives in this bill to encourage home buying, that the problem is one of demand. But that’s not true. The current housing crisis is not due to a lack of buyers, but a lack of qualified buyers. In the current economic crisis, there is a lack of housing credit. Even banks that have taken TARP money, ostensibly to free up assets in order to extend credit, are not offering credit as easily as before. Perhaps that’s a good thing. But the bottom line is that with limited mortgage credit available, home ownership will not increase, tax credit or no tax credit.

Which brings us to the next issue: how much are these homes? I’m betting about $15,000 more than they would be without the credits. Credits are dollar for dollar reductions in tax due (not like deductions which are reductions in taxable income). More or less, a tax credit is like a “dollars off” coupon. That means extra dollars in your pocket. Good, right? Well, wait a second. If I’m selling you a home and I think you’ll pay $150,000, what do you think I’ll ask for the home? Not $140,000. These tax credits will likely have the result of artificially inflating market prices – remember, sellers now understand that there’s a huge credit at play.

Think I’m kidding? The NY Times ran a great piece that linked the capital gains tax breaks for homeowners in 1997 to the “bubble” that contributed to the current crisis. The tax break is said to have created a “consumption binge”, encouraging folks to buy and sell more than they would have otherwise. The Times cites a recent study by an economist at the Federal Reserve suggested that the number of homes sold subject to the capital gains tax break was almost 17% higher over the last decade than it would have been without the law. Buyers who took advantage of the capital gains break also reported spending more money and buying “more house” than they might have otherwise – a choice which many later regretted.

Of course, the tax law in and of itself did not result in the fall of the housing market. There are a host of factors at play: poor lending practices, unpredictable interest rates and overconfidence in the market all contributed. But what the tax provision did is favor one asset, real estate, over all over assets. The bill didn’t encourage savings or other investments. It didn’t encourage small business owners to invest in their own businesses. The bill simply encouraged folks to buy (and sell) real estate. And isn’t this what we’re doing all over again?

Why aren’t we encouraging saving? Why aren’t we offering real tax incentives for small businesses? Why not encourage re-investments in other markets? Instead, we’ve again singled out real estate as the most important asset in our investment arsenal. And in the process, I think we’ve changed what it means to own a home. Buying and selling homes as assets is a recent development. Prior generations bought houses to live in, not sell.

Of course, it makes sense in the abstract. Home ownership in the US is the “American dream.” In fact, we already subsidize home ownership through a mortgage interest deduction that, according to the Tax Foundation, will cost the government $100 billion for 2008. That is nearly half, annually, of what taxpayers are expected to contribute to rescue Freddie Mac and Fannie Mae. It is nearly ten times more each year than the entire housing bailout is estimated to cost taxpayers. But we don’t mind because that deduction benefits all Americans, right? Nope. Only about 30% of American taxpayers claim the deduction on their tax returns. Statistically, not overwhelming. Yet, we continue to push the idea of home ownership through tax policy.

By linking home ownership to the American dream, we’ve come to equate home ownership with the idea of prosperity. But here’s some food for thought. Home ownership in the US traditionally hovers about 70% – less than that of Mexico and India, nations that most believe are less prosperous than the US. That number is also far above the home ownership rates in Japan and Germany, which (at least before the global plunge) most would argue are countries with thriving economies.

So this all begs the question: why make home ownership the cornerstone of our economic revival?

We talk about trying to encourage those who could not otherwise do so to “follow the American dream” and purchase a home as if it will make everything better. The reality is, however, that this tax credit (as with the mortgage interest deduction) does not facilitate access to affordable housing for most Americans and it may do more harm than good. I’ve said before – and I’ll say it again – following the spectacular fall of the real estate market, perhaps it’s wise to reconsider whether promoting home ownership through tax policy is really the best use of our government dollars. What do you think?

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Author

Kelly Erb is a tax attorney and tax writer.

Comments

  1. This is a tough one. Encouraging savings would have been a great idea all along (by which I mean over the past 50 years or so), but at this point, it would just put the economy deeper into the icebox. But I’m skeptical that a tax credit for buying a house is going to stimulate home sales much at all. Sitting across the table from tax clients (admittedly, not clients who own houses), people’s thinking is extremely short-term. Rationally, they should know that they now have an extra $7,500 to spend on a house — but that’s not how people think. They do not think in terms of tax credits when they file next year — cash flow right now is the only thing they understand. If you sent them a check for $7,500, with the stipulation that it could only be used to buy a house, that would make them offer more for the house — a tax credit, not so much. (That’s not counting us tax geeks, who are supposed to think differently.) And if you don’t have the money to buy a house, a credit isn’t going to make the difference. This idea is just a vote sop, pure and simple — but in any case, it isn’t likely to matter.

  2. Robert Urio Reply

    You brought up some very interesting points.

    However, I have been looking for houses the past couple of months and have seen that most people are asking too much for their current homes; and I can’t blame them. Who wants to take a loss on a house?? On Long Island, the value of houses has dropped almost 20% over the past 3 years. The sellers want to sell at around the value of a few years ago, while the buyers want to buy at the current value. This is making it nearly impossible to buy or sell a house in this market. I believe that this credit will not force sellers to increase their asking price by $15,000, because they will still not be able to sell their house for that asking price. Instead, this will motivate buyers to purchase houses closer to the sellers asking price and above the current FMV of the house. There are many people who can not sell their homes right now, becuase they will take too much of a loss. This will help out in that situation.

  3. FOR THOSE WHO BOUGHT IN JANUARY:
    THE HOUSE PASSED THE BILL FOR A $7500 TAX CREDIT THAT DOESN’T NEED TO BE REPAID AND IS AFFECTIVE FOR PURCHASES OF HOMES AFTER 01/01/09.
    THE SENATE CHANGED IT TO A $15,000 TAX CREDIT BUT IT IS ONLY AFFECTIVE FOR PEOPLE WHO PURCHASES AFTER IT’S SIGNED.
    IF THE SENATE PASSES THERE’S TODAY, THEN THERE WILL BE A MEETING BETWEEN MEMBERS OF THE SENATE AND MEMBERS OF THE HOUSE TO WORK OUT THE DIFFERENCES BETWEEN THE 2 BILLS.
    I BOUGHT IN JANUARY SO I OBVIOUSLY WANT THE $15,000 TAX CREDIT THE SENATE PROPOSED BUT WITH THE START DATE THE HOUSE PROPOSED.
    YOU NEED TO MAKE YOUR VOICE HEARD AND CONTACT YOUR SENATORS AND HOUSE REPRESENTATIVE. THIS IS AMERICA SO YOUR VOICE IS YOUR POWER. E-MAIL THEM OR CALL THEM. HERE IS A CONVENIENT NUMBER. CALL AND ENTER YOU ZIP CODE AND IT WILL GET YOU IN CONTACT WITH ALL OF YOUR CONGRESSMEN. DECISIONS ARE BEING MADE, DO IT NOW. 1-866-924-NAHB (6242)

  4. If the credit is non-refundable in the senate version, it doesn’t really help folks on the low end of the totem pole move up to home ownership — where the credit could actually move some people into home ownership who wouldn’t otherwise be there, albeit a modest gain. At least we’d be helping those folks that might not otherwise make it. I think you put your finger on the crux: this is intended to bolster prices, and therefore those who already have the assets. What is the income level for realizing the full $15,000 credit (over two years)? 65,000?

  5. A client came in – he sold a house for $75,000 to one of his tenants. A wrap around mortgage deal. Last year and the tenants were in the home on 12/31/08. The tenant filed their return and got the $7,500 rebate. They paid my client $3,750 of it as a down payment on their home. They then sold the home back to my client for $50,000 (a loss). Now they don’t have to repay the loan. The client then sold the house back to the tenant for $21,000 (it’s actual worth, I guess) and subtracted the $3,750 down payment. And it does not appear to me that any laws or rules were broken. Any comments?

  6. I dunno, sounds like fraud to me. If the home was worth $21,000, then that should have been the sale price and thus, the credit would have been limited to $2,100. The fact that the home was sold more than once – to the same person – for more than FMV at least once – says to me that the transaction was bogus and was only contemplated for purposes of getting the credit. If the credit increases, I’ll bet we’ll see more of this.

  7. It does indeed sound like fraud. However it does not appear to be so. Obviously it is against the “spirit” of the legislation. And our courts have, at their own convenience, sometimes decided that the “spirit” was important and sometimes a “strict reading” is important depending on what they were trying to accomplish. However something is worth what someone will pay for it – as long as it is at arms length (no family member involved) so my question remains – has any law been broken? Certainly the selling of the residence to the same person is suspicious however I have seen folks default on a wrap around mortgage and re-buy the same residence with another down payment a day or so later – in fact, I have a client who seems to specialize in selling wrap around mortgages, having the folks default, and reselling them the same place a day or so later and doing this with amazing regularity. So while it may seem like fraud it appears to me that it may just be taking advantage of a tax law that was obviously written by 3 year olds in about 2 minutes flat.

  8. I agree that the bill is poorly drafted. That’s part of the problem with rushing these things out.

    I still think it’s fraud. It wasn’t a bona fide transaction. The first sale was clearly for tax purposes only and not FMV – it’s some kind of loopy step transaction. That’s generally prohibited in the Tax Code. If I were IRS, I’d argue that the entire transaction was one sale for $21,000 – credit limited to $2,100, no loss. I think IRS would prevail.

    And there are all kinds of issues related to the original seller. He has a substantial gain in 2008 (not sure of basis but assume it’s less than $21k), not his residence, so not exempt. His loss is artificial.

    Of course, notwithstanding that, your clients are “lucky” that they did this on 12/31 – if they had tried in ’09, they wouldn’t have qualified for the credit because of the resale (in the same tax year). Of course, it’s interesting that they paid the down payment after the “purchase” of the house – not sure if it was considered proper sale on 12/31 (notwithstanding the whole step transaction issue). Wouldn’t have touched this one with a 10 foot pole. 😉

  9. If you sell your home to a non-relative before you’ve repaid the loan, you’ll only need to repay the loan to the extent of the gain on the sale of your home. If you have a loss, you won’t have to repay the balance of the loan. The amount of the homebuyer credit not repaid will reduce your cost basis. So, be sure to keep all receipts for improvements you make to your home. (This refers to the 2008 credit.)

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