Don't Mess With Taxes

The House Ways and Means Committee has signed off on a measure that would provide $2 billion in tax relief over the next decade for homeowners facing foreclosure-related tax bills.

The Mortgage Forgiveness Debt Relief Bill of 2007 (HR 3648) would permanently remove from tax calculations any forgiven debt afforded homeowners who face foreclosure or renegotiate their mortgage with lenders.

Currently, debt forgiveness is taxable income, meaning some people who lose their homes also end up owing the IRS (as blogged about here; other foreclosure tax issues discussed here and here).

But under Congress' pay-go rules that require lawmakers to come up with money to offset any new tax breaks, the funds for this foreclosure tax break would come from sellers of second/vacation homes and rental properties.

Unanimous, but with reservations: And while the bill was unanimously approved by the tax-writing committee, some members have issues with it.

Rep. Sam Johnson, R-Texas, questioned the permanent status of the tax relief; he prefers a three-year break, which is what Dubya also proposed.

Louisiana Rep. Jim McCrery, the committee's ranking Republican member, expressed concern that tightening capital gains rules on property used as vacation homes and rentals could cause a worsening housing slump, especially on the east and west coasts.

That sentiment was shared by Johnson, who said, "It seems to me to be a luxury tax" that will affect coastal areas, mountain states and resort areas.

And another Lone Star State Republican, Kevin Brady, preferred the cost of foreclosure tax relief be borne more by lenders and real estate speculators that he said helped create the subprime lending crisis.

W&M Chairman Charles Rangel, D-N.Y., however, dismissed such concerns, saying that "it's so much easier to give the tax break than to pay for it."

Rangel also cited support for the provision from industry trade groups such as the National Association of Realtors, the National Association of Home Builders and the Mortgage Brokers Association.

The Realtors group, Rangel told his colleagues, supports the the vacation-home provision because it "does not eliminate any tax benefit, but rather tightens the requirement'' for qualifying for the exclusion from capital-gains taxation on the sale of a home.

Tweaking current home sale tax breaks: Under current law, homeownership -- including second and/or vacation properties -- offers many nice tax breaks.

One of the best breaks is the exclusion of capital gains upon sale; that's $250,000 for single taxpayers or $500,000 for married couples filing jointly as long as they meet certain requirements.

When property owners have two homes, it's not unusual for them to sell their primary residence, exclude the profit from capital gains and then move into the second house. After living there for two years, they can repeat the tax break process with the sale of the other house.

But if H.R. 3648 becomes law, only a portion of the profit on a vacation home would be excluded from tax. The exact tax-free amount would depend upon how long the owners had held the property, rather than how long they lived in it.

Questions quickly arose: As is always the case with tax measures, questions about the bill's finer points came up almost immediately.

Critics say the legislation is unclear on the meaning and timing of "unqualified'' uses of a house for rental purposes.

Some tax experts also say the Joint Committee on Taxation's overview (full document here) appears to make a math mistake involving depreciation costs. And speaking of math, you can check out the JCT's estimates of the bill's revenue effects here.

Those questions are just a few of the things lawmakers will have to deal with when the bill goes to the full House for consideration, which is expected to happen in November.

But the measure is likely to retain its general focus: Narrowing the loophole that allows taxpayers, and usually the wealthier ones, to shelter gains from rental properties and vacation homes by briefly treating the homes as their "principal" residences.