NAR Government Affairs summary of “fiscal cliff” legislation as passed by the House and the Senate. UPDATE: President Barack Obama has signed the agreement into law.
Real Estate Provisions in “Fiscal Cliff” Bill
On Jan. 1 both the Senate and House passed H.R. 8, legislation to avert the “fiscal cliff.” The bill will be signed shortly by President Barack Obama.
Below is a summary of real estate related provisions in the bill:
Real Estate Tax Extenders
• Mortgage Cancellation Relief is extended for one year to Jan. 1, 2014
• Deduction for Mortgage Insurance Premiums for filers making below $110,000 is extended through 2013 and made retroactive to cover 2012
• 15 year straight-line cost recovery for qualified leasehold improvements on commercial properties is extended through 2013 and made retroactive to cover 2012.
• The 10 percent tax credit (up to $500) for homeowners for energy improvements to existing homes is extended through 2013 and made retroactive to cover 2012.
Permanent Repeal of Pease Limitations for 99% of Taxpayers
Under the agreement so called “Pease Limitations” that reduce the value of itemized deductions are permanently repealed for most taxpayers but will be reinstituted for high income filers. These limitations will only apply to individuals earning more than $250,000 and joint filers earning above $300,000. These thresholds have been increased and are indexed for inflation and will rise over time. Under the formula, the amount of adjusted gross income above the threshold is multiplied by three percent. That amount is then used to reduce the total value of the filer’s itemized deductions. The total amount of reduction cannot exceed 80 percent of the filer’s itemized deductions.
These limits were first enacted in 1990 (named for the Ohio Congressman Don Pease who came up with the idea) and continued throughout the Clinton years. They were gradually phased out as a result of the 2001 tax cuts and were completely eliminated in 2010-2012. Had we gone over the fiscal cliff, Pease limitations would have been reinstituted on all filers starting at $174,450 of adjusted gross income.
Capital Gains
The Capital Gains rate stays at 15 percent for those at the top rate of $400,000 (for individuals) and $450,000 (for those filing a joint return). After that, any gains above those amounts will be taxed at 20 percent. The 250/500k exclusion for sale of principle residence remains in place.
Estate Tax
The first $5 million dollars in individual estates and $10 million for family estates are now exempted from the estate tax. After that the rate will be 40 percent, up from 35 percent. The exemption amounts are indexed for inflation.
Tax rates would remain the same for most households and mortgage cancellation relief is extended in a budget package passed by the U.S. Senate early this morning to avert the so-called fiscal cliff. The House today could take up the bill, which NAR has been monitoring closely because the fiscal cliff’s automatic tax increases and federal spending cuts involve programs important to real estate and impact household wealth. Based on what the House does, the provisions in the Senate bill could change in the final bill. UPDATE: President Barack Obama has signed the agreement into law.
The “American Taxpayer Relief Act of 2012’’ passed on a bipartisan 89-9 vote in the middle of the night and extends current tax rates for all households earning less than $450,000, and $400,000 for individual filers. For households earning above these limits, tax rates would revert to where they were in 2003, when taxes were reduced across the board. That means taxpayers in the highest bracket would pay taxes on ordinary income at a rate of 39.6 percent, up from 35 percent.
The tax rate on capital gains would also remain the same, at 15 percent, for most households, but for those earning above the $400,000-$450,000 threshold, the rate would rise to 20 percent.
Importantly from NAR’s perspective, the exclusion from taxes for gains on the sale of a principal residence of up to $500,000 ($250,000 for individuals) remains in effect, so only home sellers whose income is $450,000 or above and the gain on the sale of their house is above $500,000 would pay taxes on the excess capital gains at the higher rate (with corresponding numbers for individual filers). For the vast majority of home sellers, there is no change.
The bill also reinstates provisions that phase out personal exemptions and deductions for incomes over $250,000 for singles and $300,000 for couples.
A number of what lawmakers call extenders are in the bill. Extenders keep in place expiring tax provisions. Of most interest to real estate, the bill would extend mortgage cancellation relief for home owners or sellers who have a portion of their mortgage debt forgiven by their lender, typically in a short sale or foreclosure sale for sellers and in a modification for owners. Without the extension, any debt forgiven would be taxable, which, for underwater households, represents a financial burden. The extension is for one year and is in Sec. 202 of the bill.
Also extended is the deduction for mortgage insurance premiums.
In two other important provisions, the alternative minimum tax (AMT) is permanently adjusted for inflation, making it unnecessary for Congress to adjust it each year. The AMT was enacted in 1969 to help ensure a minimum tax bill for high-income households that would otherwise minimize their taxes by shielding much of their income in deductions and using other tax strategies. Because it was never indexed to inflation, AMT threatens to catch middle-income households in the tax, so Congress each year adjusts it. Now the adjustment would be permanent.
The other key provision is a change in the estate tax so that estates would be taxed at a top rate of 40 percent, with the first $5 million in value exempted for individual estates and $10 million for family estates. Currently, the top rate is 35 percent.
The other side of the fiscal cliff is hundreds of billions of dollars in automatic, across-the-board federal spending cuts, with a disproportionate share of the cuts affecting defense spending. The Senate bill would push back the deadline for the cuts for two months.
Congress today (Dec. 31) continues to wrestle with what to do about the fiscal cliff, the hundreds of billions of dollars in automatic tax increases and federal spending cuts that take effect at the end of the year unless lawmakers act to avert it.
If Congress does act before midnight tonight, there are a number of things they can do. They could pass a short-term patch to get us into 2013 without major disruption to tax rates and spending programs, or they could take some large-scale action to avert the cliff and make big budgetary changes at the same time. If they don’t act by midnight tonight, and the country goes over the fiscal cliff, they could still take action early in 2013 to address tax issues and spending cuts, restoring some provisions retroactively. There are many scenarios and, as of this writing, it’s impossible to know exactly how things will play out.
Negotiations were conducted over the weekend and were expected to proceed all day today. NAR will provide an update to its members once negotiations are ended.
With this very fluid situation as a backdrop, NAR Chief Economist Lawrence Yun and NAR Director of Tax Policy Linda Goold sat down last week, on Friday, Dec. 28, for a short discussion on what real estate interests are at stake in this debate. Among other things, if no action is taken, tax rates could rise across the board to their 2003 level, before they were lowered by the Bush-era tax cuts. That means, among other things, the top tax rate could revert to 39.6 percent, from 35 percent today. Tax rates for lower income tax brackets would also rise.
The capital gains tax rate could rise as well. It’s currently at 15 percent, and it could possibly return to 20 percent. Should that happen, most home sellers should nevertheless remain protected from a tax increase upon sale of their home because the $250,000-$500,000 caital gaims tax exclusion remains in place, so only sellers whose gain is more than the exclusion amount would face the higher tax rate.
The alternative minimum tax (AMT) could change and become applicable to far more tax filers than is the case today. Goold says more than 30 million households could find themselves facing an AMT hit, up from about 4 million households today.
And mortgage cancellation relief, which helps underwater sellers who’ve had some mortgage debt forgiven by their lender, could lose that relief—at least temporarily— because it’s set to expire at the end of the year.
These are just some of the real estate impacts. In the 6-minute video above, Goold and Yun talk in more detail about what to look for should Congress end the year without taking action to avert the cliff.
To respond to NAR’s Call for Action that Congress should do no harm to real estate by considering changes to the mortgage interest deduction, either as part of the fiscal cliff discussion or as part of broader tax reform in 2013, go to www.REALTORActionCenter.com.
The “fiscal cliff” has quickly become a commonly used term, but exactly what it means isn’t all that clear, especially for real estate. At it’s most basic level, it refers to sweeping tax cuts enacted a decade ago that will expire at year’s end, so tax rates will automatically rise to where they were before, while at the same time automatic spending cuts—the sequestration enacted when the government’s borrowing limit was raised a year ago–will take effect. Thus, the economy faces a two-pronged hit: taxes going up while federal fiscal spending goes down.
If Congress does nothing, that double hit would mean a negative economic impact of about $650 billion, enough to shrink the economy by 4 percent and push the country back into recession, says NAR Chief Economist Lawrence Yun.
For real estate, that has the potential to derail the recovery that’s been slowly taking hold. Foreclosures would rise, home values would drop, hurting households but also hurting FHA, which could get hit with another wave of bad loans. That could put FHA into financial trouble.
Against this background, the federal government will be looking at a lot of options for averting the cliff while also lowering the federal budget deficit for the long-term. That puts the mortgage interest deduction in the spotlight. But is it a good idea to make changes to that tax provision?
Without a doubt, changing the rules of the game on MID now would mean a tremendous hit on real estate markets and household finances, and it could deal a blow to the broader economy, says Yun.
He and NAR economist Danielle Hale look at the different pieces in play under the fiscal cliff debate and also the economic impact of changing MID in the 9-minute video above. The information is intended to be helpful as you try to put the fiscal cliff conversation into perspective.
Read more on the pro and con of modifying MID in a Dec. 10 segment of The Diane Rehm Show.
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