The phasing out of the Bush administration’s tax cuts, changes in reporting of 1099 income, and tax increases related to the health care bill are just around the corner. Will these have a negative effect on the fledgling real estate recovery?
Regardless of where you stand politically, there are big changes coming that can have a significant impact on the real estate industry. The biggest challenge is that thousands of pages of legislation have been signed into law, but the rules and regulations that determine how the law is administered are still being written. As a result, it’s very hard for anyone to know exactly what to expect until the rules and regulations are published.
For example, the health care bill changes how "miscellaneous income" is reported. The original bill seems to require anyone who purchases $600 or more of business products to issue a Form 1099-MISC to the company from whom they purchased the product. In other words, if I buy $600 of office supplies at Staples, I have to give Staples a Form 1099.
Recently, four Democratic senators asked the Internal Revenue Service to not enforce that provision. This creates an interesting quandary: Do businesses want to run the risk of not complying?
The health care bill increases the Medicare tax. Now you may be wondering what this has to do with real estate. That provision, at least as written in the law currently, will force certain owners of real property to pay an extra 3.8 percent in taxes when they close a real estate transaction.
Currently, there appears to be quite a bit of misinformation regarding the provisions of this bill and how it will influence real estate sales. Part of this is due to e-mails circulating on the Web proclaiming, "Did you know that all real estate transactions are subject to a 3.8 percent sales tax? On a $400,000 home that would be an extra $15,200."
This statement is simply wrong. First, not all real estate sales are subject to this tax. Second, you cannot predict someone’s tax liability without looking at their total income and deductions.
When does the new Medicare tax apply?
The new Medicare tax will hit a limited number of homeowners when it goes into effect in 2013. The tax applies only to single individuals who make more than $200,000 per year and married individuals filing jointly who earn more than $250,000. Clearly, only a small percentage of homeowners exceed these thresholds.
Even for these high-income individuals, however, the tax doesn’t kick in on the homeowner’s primary residence until the owner’s profit exceeds $250,000 if single and $500,000 if married. In other words, people can continue to pull out $250,000 of tax-free profits from their primary residence if they are single and $500,000 if they are married. Any amount exceeding these limits will be subject to the capital gains provisions as well as the 3.8 percent health care tax.
The fly in the ointment
Only single-family, primary residences are exempt from this rule, provided the owners do not exceed the income guidelines and do not exceed the $250,000/$500,000 profit thresholds at time of sale. The new tax will apply on all other transactions, including luxury real estate sales, second homes and rental properties.
According to FactCheck.org, here are two examples of how individuals might be liable for the extra tax.
- A single executive making $210,000 a year who sells his $300,000 ski condo for a $50,000 profit. His tax on the sale of that vacation home would amount to $1,900, in addition to the capital gains tax he would have paid anyway.
- An "empty nester" couple with combined income of over $250,000 a year who sell their $1 million primary residence to move to smaller quarters. If they cleared $600,000 on the sale, they would be taxed on $100,000 of the profit (the amount over the $500,000 exclusion). Their health care tax on the sale would amount to $3,800 over and above the usual capital gains levy."
What’s not yet clear is whether this tax will have to be collected by the closing agent as in the case of FIRPTA (Foreign Investment in Real Property Tax Act) or whether the individual will pay the tax when they report their 1040 "income."
The luxury real estate, second home and investment real estate markets continue to be depressed in most areas due to surpluses on inventory, uncertainty in the marketplace, and lack of financing. Many investors are sitting on their cash waiting to see what will happen. What’s unclear at this time is whether this tax will deter investors from snapping up substantial parts of the bank-owned (REO) and short-sale inventory (the so-called "shadow inventory") as these properties come on the market.
If investors withdraw from the market because they can’t get properties "to pencil" (i.e., be profitable after expenses), then we could be facing an even larger supply of homes that will have the predictable result of causing prices to fall even further.