How the Fiscal Cliff Could Impact the Housing Recovery

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Everyone agrees the economy will falter if we go off the fiscal cliff, but how will the tax increases and spending cuts it will trigger impact the housing market?

  1. Reduced housing demand and construction:  Most experts predict the combination of tax increases and spending cuts will push the economy back into recession. This means both new construction and demand for existing housing will wane, quickly reversing the six-month old housing recovery.
  2. Dramatic reduction in short sales:  Failure to reach a budget deal could mean the elimination of the Mortgage Debt Relief Act of 2007, which allows borrowers to avoid paying taxes on the amount of forgiven debt. If eliminated, homeowners who complete a short sale would have to pay income tax on the amount of debt relief. This would deter banks from approving short sales and could weaken home price gains and slow the housing recovery.
  3. Less capital flows to real estate:  If lawmakers don’t act, the capital gains tax will increase from its current 15% to 20% at the start of the year. This increased tax would affect profits made from property sales, a possible deterrent to investing in real estate. The sale of primary residences are exempt from this—up to $250,000 for individuals or $500,000 for a married couple filing jointly.
  4. Increase in mortgage insurance costs:  On January 1, this mortgage insurance tax deduction is set to expire, which will slightly raise costs for those who put less than 20% down and are required to purchase mortgage insurance.

Even if Congress and the President can make a deal on how to reduce spending and raise revenue before the end of the year, it doesn’t mean the real estate market is off the hot seat. Much will come down to the specifics of the agreement, and the challenge for lawmakers will be finding a way to reduce the federal deficit without stunting the housing and economic recovery.

The primary concern most homeowners have is how lawmakers will deal with current tax deductions for  interest on home mortgages. Once considered untouchable, elected officials appear to be considering reducing it or eliminating it. Getting rid of it entirely would provide the federal government with an additional $100 billion in revenue a year, which is still a fraction of the 2012 deficit of $1.1 trillion. By comparison, the president’s proposal to raise taxes on the wealthiest two percent of Americans would raise about $160 billion per year for the next decade.

A homeowner with a $100,000 mortgage would receive about $520 in tax savings the first year and $15 in the final year of a 30-year mortgage with interest at 3.5%. For someone with a $1 million mortgage, the savings would be around $9,714 the first year and $282 in the final year. For an estimate of how much you’d save, check out the handy calculator at Yahoo Homes.

The mortgage deduction unquestionably supports the housing market by making homeownership significantly cheaper, especially in the first few years of a mortgage. However, critics argue the bulk of the money saved is by wealthier homeowners and little of it ends up in the pockets of the middle class. Consider it a microcosm for all the disagreements in Congress right now, which is exactly why no one is quite sure how an agreement will be reached or what the future holds for the housing recovery.

Ryan Nickum