Friday, December 7, 2012

Fiscal Cliff Crisis or Financial Stability for 2013?

What will the effects of this so-called Fiscal Cliff bring to real estate in 2013?  We've all heard of the potential economic disaster if Congress fails to keep the Bush-era tax cuts in effect. Everyone's taxes will go up by thousands of dollars. But this is just the tip of the iceberg for the real estate industry.

In addition to overall taxes increasing after January 1st, the Mortgage Forgiveness Debt Relief Act may also be allowed to expire at the end of the year. If this happens we can potentially see a drop in home sales by as much as 20% in 2013. How can this be possible?  If homeowners currently underwater choose to short sell their home, they will be required to report their debt cancellation as income to the IRS. This can have a devastating effect on short sales as fewer people will want to take this route and may instead be forced into foreclosure.

In addition, if Congress and the Federal Administration force us off this fiscal cliff, we may also experience a reduction in mortgage interest deductions. The mortgage interest deduction has been a mainstay for decades and has helped spur first-time home purchases.

If the Bush tax cuts are allowed to expire, NBC News states, the current capital-gains tax of 15 percent will rise to 20 percent. Alan Kufeld, a principal with accounting firm Rothstein Kass and an advisor to wealthy families, explains that families who sell a second home that they’ve owned for more than a year pay capital-gains taxes on the difference between the sale price and their original purchase price (minus certain fees, improvements and other deductions).

An example, states NBC News, is a $38 million home purchased for $8 million with $2 million in improvements could show a gain of about $28 million. The current federal tax bill on that gain would be around $4 million. If taxes go up next year, the tax would be $5.5 million – a difference of $1.5 million.

Currently, there's a cap on mortgage deductions for loans up to $1,000,000. Anything higher is capped on your itemized 1040 return. A number currently being discussed in Washington is $500,000. Since the average price of a home in the U.S. is only $170,000, lowering the cap to $500,000, according to the Greenwich Citizen, would be easy for Congress to get passed, since in most of the country it would only affect the rich.

In an extreme case, the mortgage insurance deduction may also be eliminated. These tax deduction losses would likely result in more people continuing to rent, slowing down home purchases.

As for commercial real estate, according to the San Francisco Chronicle the Fiscal Cliff could result in a huge drop in office space demand, resulting in as much as a 20 basis-point increase in vacancy rates with rents only moving sideways at best.

However, not all is doom and gloom. Most believe that our lawmakers will not allow us to dive off the fiscal cliff and will in fact come to some compromise by the end of the year. If this does in fact occur, the real estate industry will continue to strengthen with home values and home sales increasing throughout 2013. Commercially, if we are able to avoid the cliff, we could see as many as two million new jobs created in 2013 and potentially a drop in vacancy by as much as 70 basis-points.

Plus, we may find compromises which could limit certain tax increases and mortgage deductions. If this takes place, we may find mortgage interest deductions being kept intact, but limited to less than the current interest of one million dollars. Either way, we are sure to see a greater level of home sales closing prior to the end of year.

Whether we fall off the Fiscal Cliff or Washington gets their act together and comes to an effective compromise, real estate will continue to be bought and sold and life will continue. The devil will always be in the details and every situation is different, whether you’re a homeowner or investor. The key is to know how the law will affect you personally and to plan various alternatives accordingly.


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