‘Fiscal cliff’ bill addresses some key housing issues

Battle over mortgage interest deduction still to come

When the monthlong congressional game of chicken known as the "fiscal cliff" ended late last night in the House of Representatives, housing and real estate emerged as winners on most key issues.

The Senate bill that finally passed the House by a 259-167 vote extended a number of federal tax code provisions that are important to homebuyers, sellers, builders and real estate professionals.

The bill also made permanent the Bush-era reduced tax brackets for all but the highest income earners in the country, along with a permanent "patch" to the increasingly troublesome alternative minimum tax (AMT) that threatened millions of middle-income homeowners with higher taxes.

Here’s a quick overview of what the legislation means for housing:

Mortgage Forgiveness Debt Relief extended through 2013

For huge numbers of financially distressed owners of homes with underwater mortgages, this was the biggest issue in the entire fiscal cliff debate. The mortgage debt relief provisions in the tax code, first enacted in 2007, expired at midnight Dec. 31.

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Had Congress not acted, the tax code would have reverted to its pre-2007 treatment of mortgage principal reductions or cancellations by lenders, whether through loan modifications, short sales, deeds-in-lieu or foreclosures: All principal balances written off would be treated as ordinary income to the homeowners who received them.

For illustration, if a lender wrote off $100,000 of debt to facilitate a short sale, the seller would be taxed on that $100,000 at regular marginal rates, just as if he or she had earned it as salary.

A return to taxation of principal reductions would have disrupted short sales — a growing segment of the home real estate market — in 2013, and almost certainly would have encouraged more distressed owners to opt for foreclosure and bankruptcy.

Deduction of mortgage insurance premiums

The bill retroactively extended this benefit to cover all of 2012, plus continues it through 2013. Qualified borrowers who pay private mortgage insurance premiums or guarantee fees on conventional, low down payment home loans, FHA, VA and Rural Housing mortgages will be able to write off those premiums along with their mortgage interest on federal tax returns. The retroactive feature is crucial because Congress had allowed this deduction to lapse at the end of 2011. There are limitations, however: The write-off is available only to borrowers who have an adjusted gross income below $110,000.

Tax credits for energy-efficiency home improvements

This benefit provides modest tax credits of $200 to $500 for owners who install energy-efficient windows, insulation and other upgrades designed to cut energy consumption. The bill covers improvements made during 2012 and 2013.

Tax credits for new energy-efficient new houses

This allows builders and contractors to claim a $2,000 tax credit on new homes constructed in 2012 and 2013 that meet federally specified energy-conservation standards. The bill also extends credits for U.S.-based manufacturers of energy-efficient refrigerators, clothes washers and dishwashers. As with other energy-related tax provisions, this had expired last year and will now be continued through 2013.

So what’s negative in the fiscal cliff compromise bill for real estate?

Not a whole lot for homeowners who aren’t in the highest income brackets. But for those who are, there are provisions that likely will inflict some pain.

Start with marginal tax rates and capital gains. If you earn $400,000 or more as a single filer or $450,000 as a joint filer, your new marginal federal tax rate is 39.6 percent.

You also get hit with a 20 percent rate on long-term capital gains, such as those from investment real estate and home sales that rack up gains beyond the $250,000/$500,000 thresholds.

Also, the new "Obamacare" 3.8 percent surcharge on certain investment income, which went into effect Jan. 1, could raise effective rates on capital gains for upper bracket households to 23.8 percent. As a result, some investors in rental property and commercial real estate may begin looking again to Section 1031 tax-deferred exchanges to hang onto their profits.

For taxpayers in the 33 percent, 28 percent and lower marginal tax brackets, capital gains will continue to be taxed at 15 percent.

Perhaps the crucial question to ask about the new legislation is: What could have been in the fiscal cliff compromise package affecting real estate but wasn’t included? That’s easy: There are none of the "grand bargain" deduction limitations on mortgage interest and property taxes that had been proposed by tax system reform proponents.

But don’t assume those proposals are moribund. Quite to the contrary, they are likely to arise again this spring and summer, when broader scale debates over the shape of the tax code get under way. Once that process starts, watch out: Home real estate tax preferences like the "MID" will be front and center on the chopping block.

Ken Harney writes an award-winning, nationally syndicated column, "The Nation’s Housing," and is the author of two books on real estate and mortgage finance.

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