Will recent changes to the tax code in 2013 lead to increased home sales volume?
- No (75%, 115 Votes)
- Yes (25%, 39 Votes)
Total Voters: 154
The fiscal cliff was technically averted. Does the deal bode well for California real estate?
The deal, in short
First we careened over the fiscal cliff. Then, Congress hit the rewind button just hours after the deadline passed, turning back time and averting disaster — sort of.
The deal is neither strictly austerity measures nor a full-bore stimulus, but a compromise. For those of you who remain mystified, here are the highlights for 2013 earnings:
- the income tax rate was raised to 39.6% on singles with annual taxable income above $400,000 and married couples with a combined taxable income above $450,000;
- capital gains rates for the same high-income earners jumps back up to 20% from 15%;
- deductions (from AGI) and benefits will begin to phase out for single filers earning more than $250,000 and couples earning more than $300,000;
- the estate tax on the wealthiest estates ($5 million or more per person) increased from 35% to 40%;
- the middle class payroll tax break will expire, jumping two percentage points from 4.3% to 6.2%;
- the mortgage interest tax deduction (MID) was unaffected; and
- the Mortgage Forgiveness Debt Relief Act (Debt Relief Act)was extended for an additional year.
A scant 0.7% of American households will experience an income tax hike this year, according to the Tax Policy Center. This is due to the fact that the increased tax rate on high-earners only applies to the portion of taxable income above the $400,000 and $450,000 thresholds.
Although changes to the income tax will affect only a very few, the expiration of the payroll tax breaks affects many. Approximately 77% of households will pay more payroll tax in 2013. The payroll tax taken from each paycheck increases two percentage points on earned income up to $113,700. This takes around $1,000 annually out of the paycheck of the average California employee. That will reduce purchases and all the personal and economic benefits that amount represents. The result will be a static growth year for the average California business.
From the New York Times: Bigger tax hike for most under fiscal pact
From the White House: Fact Sheet: the tax agreement
Sacred cows stay that way
Largely viewed as a boon for real estate, the MID made it through negotiations unscathed, for now. Perhaps more significantly, the Debt Relief Act, which was set to expire in January, was extended for an additional year. The extension of mortgage debt relief will ensure that short sales and foreclosures continue at pace, rather than becoming stagnated from fear of excessive tax burdens.
So how will the recent fiscal deal affect California real estate? There are a few aspects to consider, but the short answer is, not much.
Regarding the two pieces of the tax code that directly affect real estate, the MID and the Debt Relief Act, nothing has changed. Although this means more of the same, it does bode well for future homeownership numbers. Maintaining the status quo means certainty, and certainty means stability, even if the stable ground isn’t quite where we want it to be looking forward.
first tuesday has been an outspoken advocate for repealing (or dramatically reforming) the MID for quite some time. It is a sacred cow of American politics that does little to encourage homeownership among the middle class (its supposed but largely unmet purpose). However, now’s not the time for fetishized austerity measures of any kind, so hands off the MID is fine for the time being.
Continuing the Debt Relief Act is a must. Under the Debt Relief Act, total debt forgiveness on both recourse and non-recourse loans is exempt from taxation as cancellation of debt income. And this support is still very much needed. California posted nearly 50,000 notices of default (NODs) in Q3 2012. Although this is an improvement over previous years, negative equity and unemployment continue to be formidable barriers to the housing recovery.
If the Debt Relief Act had been allowed to expire, the two million California homeowners still underwater would face one of two options:
- remain tied to their sinking ship, keeping the rest of the real estate market down as well; or
- squander whatever savings were realized through mortgage relief by writing a huge check at tax time.
Obviously, neither of these options is conducive to a continuing recovery. Bravo to Congress for having the wisdom to preserve the Debt Relief Act. Now it’s up to homeowners to take advantage of the one-year extension to rid themselves of their black-hole assets.
From CNBC: Fiscal cliff deal favors housing recovery
The payroll tax: paving the way to homeownership
Aside from the real-estate related aspects of the tax deal, the expiration of the payroll tax benefit stands to affect real estate the most, albeit indirectly.
The cold truth is middle class Americans will be hit hardest by the increased payroll tax. Prior to the deal, middle-income earners were enjoying benefits of low income tax and low payroll tax rates. The payroll tax increase is likely to eliminate any tax savings realized by continuing the Bush-era tax cuts for the middle class.
A household earning around the national average, $50,000 per annum, will continue to avoid paying about $1,000 in federal income tax. However, the two-percentage point increase in payroll taxes will offset income tax savings nearly 100%. The middle class is especially affected since all of their income is realized via labor, rather than capital gains and dividends.
Technically, this will not affect real estate buyer purchasing power in 2013. Purchasing power is determined by the price of mortgage money (interest rates) and gross income. Middle-income earners will take a hit to their spending power for goods and services, but the tax increase won’t make it more difficult for them to qualify for purchase-assist financing.
With that said, renters may find it more difficult to maintain their standard of living. Rent pays for the service of shelter that real estate provides. As disposable income is adversely affected by the payroll tax, this service becomes more expensive. Since the Gross Rents Multiplier (GRM) already shows the cost of renting to be high relative to the cost of homeownership, the increased payroll tax may constitute the tipping point for renters to consider homeownership.
Of course, this will take some educated reasoning on behalf of would-be owners. Buyer purchasing power is at an all-time high, thanks to the Federal Reserve’s creation of zero-bounded interest rates. With the MID remaining sacrosanct for the time being, and the cost of rented shelter taking more of an employee’s after-tax income, a push for homeownership is more appropriate now than ever.