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Popular Real Estate Tax Breaks are in Jeopardy

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It is time to start thinking earnestly about the implications of the so-called “fiscal cliff” that lies ahead, just weeks away. One way or another, the future is likely to take more money from our budget. The popular $250,000 to $500,000 tax-free exclusion from capital gains on the sale of a home may disappear in part or completely in the post-election effort to pay down the national deficit.

Prior to the election, a great deal of public focus had been on the presidential candidates’ proposals to shave the mortgage interest deduction. Now, the capital gains exclusion is one of the hottest topics.

The Mortgage Interest Tax Deduction

Fix the Debt and other nonpartisan, corporate-backed groups have identified the President’s National Commission on Fiscal Responsibility and Reform as the baseline for their national debt reduction campaign. The deficit commission called for eliminating or sharply reducing most tax deductions as a way of reaching a debt reduction ceiling of $4 trillion (down from $16-plus trillion today) by 2020.  With respect to housing, the commission suggested converting the mortgage interest deduction to a 15% tax credit, but tax experts think that it is possible that virtually all real estate write-offs would disappear in a vastly simplified new federal tax code. Although it’s true that the super-wealthy benefit greatly from the real estate tax breaks, it’s also true that every homeowner in America will suffer if they go away.

Tax advantages on the chopping block

Other possible erasures on the list are deductions for local and state property taxes; federal tax exemptions for interest on state government bond issues used to assist moderate and low-income home buyers; and exemptions from income tax of mortgage amounts forgiven by lenders on loan modifications and short sales.

The Real Estate Capital Gains Exclusion

Exclusion of primary home sale profits ($250,000 for single filers and $500,000 for married joint filers) is available once every two years and has been immensely popular.  A Pew Research Center study in late October indicated that many people depend on the “windfall” of tax-free gains from the sale of their residence for their retirement. Without this exclusion, growing numbers will worry about having enough laid by for their retirement. Real estate equity took a hard hit during the downturn, but prices have steadily increased for an encouraging number of months – enough to inspire many experts to say that the economy is headed back to health – and a huge amount of equity still exists in every state.

Fix the Debt has proposed a comprehensive reform plan under which owners would pay income tax at a lower rate but would also lose long-established preferences that were put in place to encourage home ownership.  Whether net monetary benefits of lower tax brackets outweigh the loss of deductions for mortgage interest and other current advantages depends on the timetables to phase in the changes and each owner’s personal circumstances.

It is in everyone’s interest to reduce the federal debt but the details of how best to achieve that goal is the critical question. Homeowners should be alert to keep a weather eye on the tax-deduction negotiations: the largest, single tax-free benefit is on the table.

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