With the clock ticking, the nation is engrossed in Washington's horse wrangling over the fiscal cliff, a nasty double whammy of spending cuts and tax hikes that experts predict could usher in another crippling recession.
But while Democrats defend entitlements and Republicans defend against tax increases, no bigger constituency seems to be more in the cross-hairs than homeowners. The popular mortgage-interest deduction (MID), long thought to have hands-off status, is now on the table as lawmakers try to steer the country away from plunging headlong over the fiscal cliff.
To what degree eliminating or reducing the MID, which costs the government an estimated $98 billion annually, impacts the housing market is debatable. While a potential change in the MID has caused a great deal of coverage in the news—and no doubt great anxiety for the average homeowner—most can sit back and take a deep breath ... for now. The MID won't be part of the fiscal cliff fix.
But that doesn't mean it enjoys a permanent presidential pardon. The MID, and all the associated homebuyer tax subsidies, will have to prepare for 2013, when large-scale reform of America's tax system will begin. In addition to the MID, here are some current tax breaks homeowners enjoy, that will come under scrutiny starting next year:
• Mortgage points: When you acquire a home mortgage, oftentimes you pay "points" up front for a lower rate. While this is technically pre-paid interest and categorized under the MID—and therefore tax deductible—it is a huge factor when refinancing or purchasing for the long term. The more points you pay up front, the lower your rate, and the lower your monthly payment.
You can deduct the points the year you purchase a home, and when you refinance you must spread the cost out over the life of the loan. This doesn't get a lot of attention in the MID discussion, but it should. Buying points at the time of purchase has incentivized borrowers to invest for the long term, and lower payments mean homeowners have the ability to build equity more quickly.
• Property taxes: Most homeowners pay property taxes to a local or state government every month above and beyond their mortgage payment. Property taxes, which are based on local government property value assessments, are deductible in most cases for those who itemize their income tax filings. The annual cost to the government for allowing the deduction for property taxes is around $48 billion.
• Capital gains: One of the juiciest benefits to owning a home comes when you sell for a profit. As a single tax filer, you can exclude from taxes up to $250,000 of profit you make on an owner-occupied sale of a home, and $500,000 as a married couple. This is in addition to income above any debt and improvement costs. The annual price tag on capital gains for primary residences is $35 billion.
• Discharge of mortgage indebtedness: This obscure tax break doesn't actually cost the government that much—about $360 million in 2009—but it is beginning to make its way into headlines because it expires on December 31. Starting in 2007, Congress said that any debt forgiven by a lender through short sale, foreclosure, or loan modification could be excluded from ordinary income. It's not hard to imagine how this tax break has benefitted those hit hardest by the housing crisis over the past 5 years. But starting January 1, if you enter a short sale on your home for $200,000 and you owe $300,000, you will owe taxes on $100,000. Assuming you're in the 28 percent tax bracket—the typical tax bracket for those in the middle class—that's an extra $28,000 added on to your tax bill at the end of the year. Chances are if you need to enter a short sale in the first place, you probably don't have the $28,000.
Home prices are finally starting to rise and the government has invested a tremendous amount of resources (quantitative easing) and political capital (major refinancing and home buying initiatives) to stop real estate values from falling. It worked, and that's reason to celebrate. But with "everything on the table" amid fiscal cliff negotiations, homeowners should enjoy the holiday season; 2013 might not be so festive.