We all know just how crazy the tax laws are in this country. The CCH version of the income tax regulations runs 14,144 pages but that’s what happens when you commandeer a revenue generating process for social engineering. And it turns out that the country’s housing policies contribute to the problems with some really crazy homeowner tax laws – some of which you may not be aware of but really should be.
Gain On Sale Of Home Is Taxable
This tax law is bizarre and it has changed over time. It used to be that if you had a gain on the sale of your primary residence it would not be taxable if you rolled the proceeds over into another home. They also allowed sellers over the age of 55 a once in a lifetime exemption of $125,000 if they didn’t roll it over. Any non-exempt amount would be taxed as a capital gain.
Then, I think it was 1997, they decided to change the rules. They did away with the rollover exemption but allowed you to take an unlimited number of $250,000 ($500,000 if you’re married) exemptions once every two years. I guess they thought they were doing everyone a favor – and in fact they probably did most people a favor. However, if you happen to live in a rapidly appreciating area, stay in your home a long time, and then need to move you get screwed under these rules. You hear all the time about someone who paid $300,000 for a place a long time ago and now it’s worth $1.2 MM. If they decide to move to an equivalent home they are going to owe taxes on a $650,000 gain ($400,000 if married) even though nothing has really changed for them economically.
One other thing to keep in mind on this rule is that any major improvements to the home count towards the cost of the home so you are well advised to keep good records. In case you are interested here are the complete rules in IRS Publication 523, Selling Your Home. it’s only 38 pages long. See what I mean?
Loss On Sale Of Home Is Not Tax Deductible
Nobody has ever given the IRS credit for being consistent. Despite the fact that they are going to tax you on any gains on the sale of your home they don’t allow you to deduct any losses on a sale. What is the logic of that except to allow them to take more money from you? That sucks – especially if over the course of several transactions you have losses and gains that cancel each other out. You pay tax even though you have no net gain.
Gain On Short Sale
There has been a long standing IRS rule that if you have an outstanding debt and that debt is eventually forgiven then you have taxable income equal to the amount of debt forgiven. That law makes perfect sense because if it did not exist then people could basically pay you by loaning you money and then quickly forgiving the debt without any tax consequence to you. Tax free income!
The problem is that this law also applies in the case of a short sale, when your lender basically lets you off the hook for some portion of your outstanding mortgage balance. For example, let’s say you sell your home for net proceeds to the bank of $200,000 but the outstanding loan balance is $300,000 and the bank allows you to walk away free and clear. In that case your bank has effectively forgiven you $100,000 of debt and under this tax law you have taxable income of $100,000.
The obvious problem is that people who are conducting short sales are typically in financial distress and the last thing they need is a tax liability on this “phantom income”. Recognizing this problem, congress has previously made mortgage forgiveness an exception to this rule under what has been known as the Mortgage Forgiveness Tax Relief Act. The only problem is that congress has typically put a rather short fuse on this act and it needs to be regularly extended.
For instance, the act expired at the end of 2013. Historically, congress has extended the act, retroactively, early in the following year but so far in 2014 it has not been extended and time is running out for the current tax year. Apparently, politics as usual is to blame. If this issue matters to you you might want to reach out to your congress people NOW.
Mortgage Interest Deduction
I saved this one for last because it’s a bit of a sacred cow in this country and many people would not agree with me that it has no business in our tax laws. Apparently the US government some time ago found it necessary to allow people to deduct their mortgage interest on their income taxes, thus subsidizing homeownership (but not renting), and artificially driving up the cost of housing by goosing demand. Why? Why? Why? Why do they do this stuff?
And if you like to get your undies all in a bunch over such matters consider that a recent HelloWallet rent vs. buy study found that in 75% of the cities that they looked at “median income families — those earning roughly $50,000 annually — got no federal tax benefit from homeownership”. In other words the subsidy is really going to the top half of income earners in the country. And, as that same study points out, the government is often subsidizing bad financial decisions.
The time is long past due to straighten out the income tax rules and replace them with something much more rational. You should know you have a problem when it takes more than 14,000 pages to document them all.
#realestate #incometaxes #taxlaws
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