Blank slate tax reform
Blank slate is a theory applied to human development asserting individuals are born without built-in mental content and that their knowledge comes from experience and perception. It appears that our lawmakers are interested in applying this concept to our tax code, which could have staggering consequences to the real estate market.
At the end of June, the Senate’s top Democratic and Republican tax-writers, Senate Finance Committee Chairman Max Baucus, a Democrat, and the committee’s top Republican, Orrin Hatch unveiled what they are calling blank slate tax reform.
The proposal calls for unspecified, but potentially substantially lower, tax rates for both individuals and corporations by eliminating current tax breaks. In order to add tax breaks back into law, the breaks would have to be justified, forcing people to come forward with creative ideas or those that would increase economic growth or aid public policy.
So what does this mean to the real estate market? Well, it depends on who you ask. Erskine Bowles who had proposed a similar plan for the president as part of the deficit commission claims that only 27 percent of taxpayers itemize deductions and do not take advantage of the mortgage interest deduction.
Real estate professionals naturally are against any change to the current mortgage interest deduction law and claim it would stop the housing recovery as well as have an impact on industries associated with home purchases.
Currently, you can claim all of the interest on your primary and secondary home up to a loan of $1 million. Some of the proposals that have been floated prior to the blank slate idea were eliminating the deduction for second homes and/or placing caps on the deduction based on upper bracket income levels. There also is a proposal to convert the deduction to a tax credit still providing some mortgage interest relief.
In addition to the annual mortgage interest deduction, there are substantial capital gains tax breaks on principal residences. Married couples filing jointly are exempt from paying income tax on the gain received from the sale of their principle residence – single family home, condominium, mobile home or even a boat would qualify as a principle residence – to a gain of $500,000. Single homeowners receive an exemption of $250,000. This benefit applies to profits on the sale which excludes the cost of the home and any big ticket improvements like renovations, additions, roofs, heating and air conditioning systems.
For example, a couple purchases a home for $200,000 and spends $100,000 on improvements; this puts their cost basis at $300,000. If they sell the home for $800,000, they would not owe any federal income tax, $500,000 exemption plus $300,000 cost basis.
Also, as long as you live in a home for two years, you can claim the deduction, therefore, you can move every two years and avoid paying capital gains on your profits. This type of exemption in addition to the annual interest deduction is what the federal government is looking at in attempting to update the tax code.
Whether or not the blank slate proposal also includes capital gains exemptions is yet to be determined. Right now, only time will tell if the Baucus-Hatch plan goes anywhere. In the meantime, if you want your voice heard, contact your Senator’s office and weigh in on the issue.
God knows we need an updated tax code, since there hasn’t been one in 27 years, but eliminating tax breaks for homeowners will keep new buyers out of the market and current homeowners in place flat lining the market.
Maybe a blank slate isn’t such a bad idea. We could start with Washington and see how long it takes them to acquire the experience and perception to really get something done.
