Tax Reform Panel Makes it Official: No More Home Equity Interest Write-offs, No Property Tax Deductions

By: Kenneth R. Harney: Realty Times
At its final meeting last week, the President's federal tax reform advisory panel intensified its assault on real estate, with new proposals to effectively eliminate most home equity-related write-offs replacing them with a 15 percent tax credit on mortgage amounts up to local FHA limits, plus a $100,000 increase in the home sale capital gains exclusion. Ken Harney reports.

If you could pocket an extra $100,000 on your home sale profits tax-free, would you give up your mortgage interest deductions and your ability to write off local real estate taxes and your state income taxes?

That's the crux of the real estate bargain proposed last week (October 18) by President Bush's tax reform advisory panel. The bipartisan, blue-ribbon group called for a 15 percent tax credit on mortgage interest, but only up to a strictly-capped loan limit, along with an end to all write-offs for state and local taxes. Only mortgage debt up to the FHA maximum loan ceiling for your area would count toward the 15 percent credit. In other words, if you had a $550,000 first mortgage and a $150,000 home equity credit line and you lived in an area where the FHA loan limit is $172,000, you would qualify for a 15 percent credit on mortgage interest paid only on the first $172,000 of your $700,000 mortgage debt. Under current tax rules, you can write it all off.

The only bone the tax reform panel threw to real estate owners last week was a proposed $100,000 increase in the current $500,000 capital gains exclusion limit for married, joint-filing sellers and a $50,000 increase for single sellers. On top of that, the panel recommended the capital gains exclusion for home sale profits be indexed to inflation. A $600,000 cap next year, for instance, would become a $618,000 cap the year after that, assuming a 3 percent jump in the Consumer Price Index (CPI).

The reform panel's plans, scheduled for formal presentation to the White House Nov. 1, called for an extensive list of other tax code changes, including an end to the alternative minimum tax (AMT) that has begun affecting large numbers of upper-middle income households, plus a cut in the capital gains rate from 15 percent to one-quarter of each taxpayer's ordinary income tax rate - a maximum rate of 8 .25 percent.

The possible elimination of mortgage interest deductions was hinted at by the panel earlier in October, and raised a predictable firestorm of protest from real estate and mortgage groups. But the recommendation to end all deductions for state income taxes and local property taxes, unveiled for the first time last week, would constitute a double-whammy for hundreds of thousands of homeowners in high-cost, high-tax states if enacted.

In an interview with Realty Times, Doug Duncan, the chief economist for the Mortgage Bankers Association of America, called the tax reform proposals "a disaster" for homeowners in states such as California, New York, Massachusetts and much of the East Coast.

"Would people continue to be able to buy houses at prices like they are paying today?" asked Duncan. "Of course not - home prices would have to decline" if tax benefits such as interest deductions and property tax write-offs were stripped out of the equation.

How serious should real estate owners and advocates take the advisory panel's recommendations? Didn't the president himself say he didn't want tax reform at the cost of homeownership? Yes, but panel members argue that a 15 percent credit for a moderate amount of mortgage interest would actually benefit far more homeowners - especially the vast numbers of people who do not itemize - than the current system, which skews benefits heavily toward upper-income owners and those who live in high-cost areas. Property tax write-offs also do not benefit moderate income and first time buyers, according to panelists, but instead subsidize upper income families overwhelmingly. The panelists point to studies conducted by the Congressional Joint Committee on Taxation and the Treasury Dept. that buttress these conclusions.

The President is highly likely to include at least some of the recommendations from the advisory panel in his budget proposals to Congress in 2006. What Congress does with those proposals is a completely different issue, especially in an election year.

Bottom line: Don't look for any drastic real estate tax changes in 2006, but do not dismiss the panel's recommendations out of hand. Revenue-raising ideas - even those that would negatively affect real estate - have ways of getting on Congress's agenda when Congress needs to raise money to restrain budget deficits. That time of reckoning - paying for costly wars and massive disaster relief and reconstruction, along with scrapping of the unpopular revenue gusher known as the AMT - may not be as far in the future as some homeowners assume.