How About This for a Shot in The Arm?

Congress Hammers Out
Breaks for Homeowners

By MARTIN A. VAUGHAN
April 23, 2008

In just a couple of years, Congress has gone from considering ways to collect more taxes from homeowners and individual real-estate investors, to dreaming up new tax breaks for home buyers. With foreclosures hitting about 7,500 a day nationwide in March, and median home prices declining in most U.S. markets, the shift in attitudes is no mystery.

Gone are the days of 2005, when an advisory panel appointed by President Bush recommended trimming the home-mortgage interest deduction to pay for lower income-tax rates. Many lawmakers scoffed at the proposal, but the fact that it was even put forward by the distinguished, bipartisan panel was remarkable in itself.

As recently as this past October, the House of Representatives passed a provision that would have raised taxes on some owners of vacation homes. It targeted owners who moved into those houses for two years before selling them, in order to benefit from the full $500,000 maximum income exclusion available for the sale of a principal residence.

Tax Credits, Tax Breaks

That provision is now nowhere on the radar. Moreover, Congress is moving toward enacting new tax credits for home buyers, and tax breaks for millions of homeowners who don't currently benefit from the ability to write off property taxes.

"The world has changed dramatically," says Linda Goold, tax counsel for the National Association of Realtors, of the rush by Congress to aid homeowners and the real-estate industry.

Who is likely to benefit from tax changes in the pipeline? And for how long? The Senate and the House Ways and Means Committees have each passed packages of tax breaks aimed at easing the housing slump. Both enjoyed broad support from Democrats and Republicans.

The first thing to know is that in order to claim any tax benefits in the current proposals, you must live in the house you are claiming them for. None of the provisions likely to become law are written to help the small-time investor in a single-family home.

Second, the tax breaks under discussion are temporary, so lawmakers can advertise them as being available "for a limited time only." However, if history is any guide, Congress is loath to let tax cuts for individuals expire once it creates them.

Standard Deduction

Both the Senate and House bills would increase the standard deduction for one year to allow those who don't itemize their taxes to take a deduction for property taxes. The increase would be capped -- the additional standard deduction is worth up to $1,000 for joint filers under the Senate plan, for example.

But nearly all homeowners already itemize so they can write off their mortgage interest, right?

Wrong. Roughly 40% of all homeowners -- about 28 million -- don't itemize. The additional standard deduction would particularly benefit people who live in modest homes and have paid off or nearly paid off their mortgages, many of whom are seniors.

As such, those people would also likely not have charitable or other deductions totaling more than the standard deduction amounts -- in 2008, $5,350, or $10,700 for married taxpayers filing jointly.

Besides the standard-deduction increase, Congress-watchers say some kind of tax credit for home buyers has a good chance of becoming law. The House wants to give first-time home buyers a $7,500 credit. The $7,000 credit offered in the Senate bill, not limited to first-time buyers, would apply only to new, unsold homes or homes in foreclosure.

A 'Buyers' Psychology'

"The whole goal here is to create a buyers' psychology," says Ms. Goold of the Realtors' group.

But some tax experts say it is more like a psyche-out. Take the proposed first-time home buyers credit, for instance. A qualified buyer can receive a maximum $7,500 from the federal government, similar to an interest-free loan, repayable over 15 years. That works out to an average of an additional $42 per month paid back to the government.

But what if, in lieu of borrowing from Uncle Sam, the strapped buyer had simply borrowed an extra $7,500 from the bank? Spread out over the life of a 30-year mortgage with a 6.5% interest rate, the borrower would end up paying an extra $48 a month.

Of course, the buyer who takes the tax credit saves $9,500 in interest costs over the long run. But the difference on the monthly payment side is small. "It raises the question: Is it really increasing the ability of the buyer to purchase that home?" says Clint Stretch, managing principal of tax policy for Deloitte Tax LLP.

The measures could still get tripped up by concerns about their cost, or by disagreements between the White House and Democrats over Federal Housing Administration provisions that are also expected to become part of the package.

* * *

LAW STUDENTS, be civic minded ... but also be tax wise.

Yale Law School last week announced it is expanding its student-loan-forgiveness program to include students in public-service jobs making up to $60,000.

Yale is one of more than 100 law schools nationwide that offers to forgive student debt, as an incentive for graduates to work for the government or a nonprofit when they graduate. But law students should be aware of possible tax consequences of such a gift, says Heather Jarvis of Equal Justice Works, an organization to promote public-interest law.

"It's an unsettled area of tax law," Ms. Jarvis says. Most schools have structured their programs so that the loan amounts forgiven wouldn't be treated as income, she said. But a 2006 court decision threw some doubt on whether law-school programs qualify for a tax exclusion.

Other schools structure their loan-forgiveness programs as a grant. In those cases, lawyers in the programs will owe some tax on the grant amounts.

In the meantime, school administrators including Associate Dean Ellen Aprill of Loyola Law School -- who blogged about the issue on the TaxProfBlog Web site -- and University of Virginia Law School Dean John Jeffries -- have asked the IRS to clarify its guidance.