The tax cuts for the “rich” that President Obama wants gone aren’t the only Bush-era reforms set to sock America’s shaky economy if allowed to expire as scheduled on Dec. 31. Turns out, there’s a critical tax break for distressed homeowners that could also go by the wayside if we go over the fiscal cliff, walloping the fragile recovery in the housing market.
The economic fallout from that alone could be devastating.
The tax relief comes into play when an “underwater” homeowner finds a buyer willing to pay less than his mortgage but doesn’t have — or is unwilling to come up with — the extra money needed to pay off the loan. In that case, he can ask the bank to agree to a “short sale,” in which the bank accepts whatever price the homeowner gets — even though it’s less than what’s owed — and forgives the remainder.
Before amended under Bush, the tax code required the homeowner to pay tax on the forgiven debt, which it treated as income. So, if a homeowner in the 30 percent bracket owed $400,000 and got the bank to take $300,000 on a short sale, he would get socked with a $30,000 tax bill, even though there would be no cash income to pay it.
Included in the Bush-era tax relief was the Mortgage Debt Relief Act, which gives homeowners a pass on the tax they would otherwise have to pay when part of their primary residence mortgage balance (up to $2 million) is forgiven. Once that break expires, along with the Bush tax rates next year, homeowners again will have to pay tax on forgiven debt.
Housing’s nascent recovery is due in significant part to sales of foreclosed homes and short sales; they’re steeply discounted and amounted to nearly one in three existing home sales last year and account for one in four today.
Obama’s used his control over failed mortgage giants Fannie Mae and Freddie Mac to “encourage” (via taxpayer subsidies) various mortgage-modification programs, and after the robo-signing scandal, the feds and all 50 state attorneys sued the banks and eventually settled for $25 billion.
As a result, foreclosures have become legally, financially and politically risky — and very drawn out affairs: In New York they take over three years on average; in Florida over two years. So the banks have been consenting to short sales — the free market’s solution to Obama’s failed housing policies.
And with these sales, prices are finally starting to recover. The median home price is now $186,000, up 7.6 percent from last year.
But once the fiscal cliff hits and the mortgage-tax relief vanishes, short sales will dry up; homeowners won’t be able — or want — to pay the new tax bill on those sales.
And one thwarted home sale sets off a chain reaction: A series of related sales also die out, because the owner of the first (and each successive) stopped sale can’t buy another house until his is sold. Enable the first sale and you get three or four more.
With the tax-relief gone, the housing market may well freeze up again. The number of home sales will plummet as each frozen sale stops several others, swelling inventories and pushing down prices.
Compounding matters, the fiscal cliff includes a steep rise in capital-gains rates: They’ll jump by a third from 15 percent to 20 percent, and with ObamaCare higher-income taxpayers will pay 23.8 percent.
That will hurt housing’s recovery, too, because people who’ve finally saved up enough money to make the 20 percent down-payments banks now require often hold those savings in appreciated stocks.
It’s bad enough that a sudden surge in tax rates on the “rich” — that is, on small business owners who produce jobs — will deal such a sharp blow to the economy, even as folks are praying for it finally to improve.
But hitting distressed homeowners with new taxes as well — and clobbering a key and still struggling economic sector, housing — could prove catastrophic.
Washington has but six weeks to act.