Tag Archives: taxpayer

Tax Reform and Home Equity Loans

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photo by Kalmia

MortgageLoan.com quoted me in Tax Reform Just Made Home Equity Loans A Lot Less Attractive. It reads, in part,

Home equity loans have long been attractive ways for homeowners to borrow money to pay for everything from major home improvements to a child’s college education. But these loans just lost a major benefit: When filing their income taxes, homeowners can no longer deduct the interest they pay on home equity loans each year.

This might make these loans less popular. The loss of the interest deduction might persuade homeowners to look for other ways to tap the money in their homes.

“From what I see, there are very limited times that home equity loans would still come in as a benefit,” said Tristan Ahumada, a real estate agent with Keller Williams Realty in Westlake Village, California.

A rush to pay off home equity loans?

And she’s not alone. Donald Daly, managing partner of REIS Group LLC in New York City and a licensed real estate appraiser, said that since January 1 he has seen a higher level of requests for appraisals from homeowners seeking to refinance their existing mortgage loans. Many of these owners are doing this as a way of paying off their Home Equity Lines of Credit, a form of home equity loan.

The reason? These lines of credit, better known as HELOCs, are not nearly as attractive to homeowners when they don’t come with the bonus of a tax deduction.

“We fully expect this trend to grow over the next weeks and months as more and more homeowners learn of the effect these changes will have on their personal finances,” Daly said.

Goodbye, deduction

In the past, homeowners who took out home equity loans or HELOCs could deduct the interest they paid on up to $100,000 of these loans. If you took out a home equity loan for $50,000, then, you could deduct all the interest you paid during the year on that loan. If you took out a home equity loan for $150,000, you could deduct the interest you paid on the first $100,000 of that loan.

When Congress in December of last year signed the Tax Cuts and Jobs Act into law, this all changed. The big tax reform legislation eliminates the home equity loan deduction starting in 2018. You can still claim your tax deduction when you file your income taxes in April of this year. That’s because you’re paying taxes from 2017.

But you won’t be able to claim the home equity loan deduction when you file on your 2018 taxes and beyond. Most of the tax cuts impacting taxpayers, including the home equity deduction rules, are scheduled to expire after 2025. No one knows, though, whether Congress will vote to continue them past that date once that year rolls around.

Existing loans aren’t grandfathered in, either. If you took out a home equity loan in 2016 and you’re still paying it off this year, you won’t be able to deduct any interest you pay on it in 2018, even if you’ve already deducted interest payments in the past.

*     *      *

Home equity loans can still work, though

Just because the tax benefits of home equity loans are disappearing, though, doesn’t mean that these loans are no longer a viable option for all homeowners.

The deduction was a benefit, but the biggest advantage of home equity loans is that they are a relatively cheap way to borrow money. The mortgage rates attached to home equity loans tend to be low. That isn’t changing.

So if you do have equity in your home and you want money to help pay, say, for your children’s college tuition, a home equity loan or HELOC might still be a smart move.

“While tax deductions are important, they are not the only reason we take out home equity loans,” said David Reiss, professor law at Brooklyn Law School in Brooklyn, New York.

Reiss said that when considering whether a home equity loan or HELOC is right for them, homeowners need to ask several important questions.

First, why do they want to take out the loan? If it’s for home improvements or to reduce high-interest-rate debt, the loan might still be worthwhile, even with the tax changes.

Next, homeowners need to look at their monthly budgets to determine if they can afford the payments that come with these loans. Finally, homeowners should consider whether they can borrow money cheaper somewhere else, taking the loss of the deduction into consideration.

“If you are comfortable with your answers, there is no reason not to consider a home equity loan as a financing option,” Reiss said.

What’s with 1031 Exchanges?

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US News & World Report quoted me in Why 1031 Exchange Investments Are Worth a Look. It opens,

With tax reform nearing final passage in Congress, one of the most underlooked, but potentially overpowering, tax-advantaged investment tools is the 1031 exchange, which was spared major changes in the proposed legislation.

The 1031 exchange, especially when related to real estate investments, is all about “timing and taxes” and the better you manage the two, the more money you can make.

What is a 1031 exchange? By and large, IRS Section 1031 covers “exchanges” or swaps of a specific investable asset (such as real estate) for another. The end game for the taxpayer/investor is to avoid having exchanges listed as taxable sales. But if they’re executed within the confines of a 1031 exchange, taxes are either significantly reduced or eliminated altogether.

The primary benefit of 1031 exchanges related to real estate investments is tax deferral, or avoidance of capital gains taxes on the sale of appreciated investment property, says Kevin O’Brian, a certified financial planner at Peak Financial Services, in Northborough, Massachusetts.
“If held inside owner’s estate at death, the asset would receive a step-up in cost basis to the market value, as of the date of death,” O’Brian says. “Therefore, heirs could avoid capital gains taxes, if sold after inheriting it as well.”
Others note that following IRS guidelines on Section 1031 are a must.
“1031 exchanges allow a real estate investor to sell one property that has appreciated in value and not pay capital gains tax so long as the investor buys another property,” says David Reiss, a professor at Brooklyn Law School. “This is a powerful tax deferral tool that many sophisticated real estate investors use. It is, however, somewhat complicated to pull off and involves some additional costs and planning so it is not for those looking for a quick and easy way to defer capital gains.”
What are the rules for a 1031 exchange? The rules governing 1031 exchanges have to be followed carefully and it makes sense to plan for it with an appropriate team of professional advisors and a reputable 1031 exchange company, Reiss says.
“Generally, the investor needs to sell the property that has appreciated in value; place the proceeds in escrow with an intermediary; and then use those proceeds to buy a replacement property within a certain period of time,” he says. “If the investor fails to follow the requirements for the exchange, he or she may be taxed on the full capital gain.”
Investors should also be sure to use a 1031 exchange company that meets specific criteria. “Not the least of which is that it’s properly insured to protect you in case your funds disappear from escrow,” Reiss says. “This has been known to happen.”

The Impact of Tax Reform on Real Estate

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Cushman & Wakefield have posted The Great Tax Race: How the World’s Fastest Tax Reform Package Could Impact Commercial Real Estate. There is a lot of interesting insights in the report, notwithstanding the fact that ultimate fate of the Republicans’ tax reform is still a bit up in the air. Indeed, C&W estimates that there is a 1 in 5 chance that a bill will not pass this year.

Commercial Real Estate

C&W states that history

suggests that tax law changes by themselves are often not key drivers for transactions or for investment performance. However, there is likely to be a period of transition and market flux as investors restructure to optimize tax outcomes with implications for the underlying asset classes. Corporations are likely to separate the real estate aspects of their businesses. (2)

The commercial real estate industry is largely exempt from the biggest changes contained in the House and Senate bills. 1031 exchanges, for instance, have not been touched. C&W sees corporations being big beneficiaries, with a net tax cut of $400 billion over the next 10 years; however, they “anticipate that the tax cut will be preferentially used to return capital to shareholders or reduce debt, rather than to increase corporate spending.” (2)

Residential Real Estate

C&W sees a different effect in the residential real estate sector, with a short-term drag on home values in areas with high SALT (state and local tax) deductions, including California, NY and NJ:

The drag on home values is likely to be largest in areas with high property taxes and medium-to-high home values. There is also likely to be a larger impact in parts of the country where incomes are higher and where a disproportionate proportion of taxpayers itemize. Both versions of the tax reform limit property tax deductibility to $10,000. While only 9.2% of households nationally report property taxes above this threshold, this figure rises to as high as 46% in Long Island, 34% in Newark and 20% in San Francisco according to Trulia data.

The Mortgage Bankers Association (MBA) estimates that 22% of mortgages in the U.S. have balances over $500,000, with most of these concentrated in high costs areas such as Washington, DC and Hawaii—where more than 40% of home purchase loans originated last year exceeded $500,000. This is followed by California at 27%, and New York and Massachusetts at 16%. (6)

C&W also evaluated tax reform’s impact on housing market liquidity and buy v. rent economics:

The median length of time people had owned their homes was 8.7 years in 2016—more than double what it had been 10 years earlier. Now that interest rates have begun to tick upward from their historic lows, the housing market may face a problem called the “lock-in” effect, where homeowners are reluctant to move, since moving might entail taking out a new mortgage at a higher rate. This leads to the possibility of decreasing housing market liquidity in high-priced markets.

All things considered, the doubling of the standard deduction and the cap on the property tax deduction is likely to have the largest impact on the buy vs. rent incentive, especially as it seems likely that there will be minimal changes to the mortgage interest deduction in any final tax reform bill. (7-8)

Republicans and the Mortgage Interest Deduction

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photo by Nick Youngson

There is a lot to hate in the Republican tax reform plan contained in the proposed Tax Cuts and Jobs Act. (click here for a summary and here for the text of the bill itself). Overall, the bill is extraordinarily regressive, heavily favoring the wealthy. There will, of course, be all sorts of compromises to this proposal as Republicans work to get it passed. But it is worth highlighting what is good about the bill as it would be a shame to lose sight of it while the sausage is being made in Congress.

The best real-estate related provision from a policy perspective is the reduction of the mortgage interest deduction. In a section of the summary with the Orwellian title, Preserving the Mortgage Interest Deduction, the Republicans outline how they will slice the deduction in half:

For so many Americans, buying a home is often the largest investment – and perhaps most important – investment they will make in their lifetime.

The Tax Cuts and Jobs Act will continue to support the American dream of homeownership by preserving the Mortgage Interest Deduction.

This ensures that hardworking families can continue to access this important tax relief as they buy, own, and maintain their home.

Policy Specifics

• Increasing the standard deduction means a simpler, fairer, and flatter tax code in which fewer taxpayers need to go through the trouble of determining whether they should itemize.

• Under the Tax Cuts and Jobs Act, taxpayers will still be able to deduct mortgage interest in excess of the standard deduction, in combination with other remaining itemized deductions, including charitable contributions and property taxes.

• The mortgage interest deduction would be available for interest paid on new mortgages for up to $500,000 in home acquisition indebtedness on principal residences.

• For existing mortgages, the plan allows for current law deduction on indebtedness of up to $1,000,000 and up to $100,000 in home equity to help taxpayers who may have relied on the current mortgage-interest deduction.

How This Policy Helps the American People

Preserving the home mortgage – and the deduction for state and local property taxes – will help more Americans of all income levels achieve the American dream of homeownership. (15-16)

This plan would cut the principal amount of a mortgage that would be eligible for the mortgage interest deduction from the current maximum of $1,000,000 to $500,000. Given that wealthy households generally take the mortgage interest deduction more often and get more bang for their buck from it, it is a regressive aspect of the tax code.

It is striking that a provision with such broad support such as the mortgage interest deduction is actually on the table. It will be interesting to see how special interests in the real estate industry will respond. My bet is that at the end of day the deduction will remain mostly untouched, even though this particular Republican proposal makes good policy sense.

Watt’s Happening with Fannie and Freddie?

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FHFA Director Watt

Federal Housing Finance Agency Director Watt testified before the House Committee on Financial Services today and gave a good overview of the decade-long conservatorship of Fannie and Freddie.  He also gave some sense of the urgency of coming up with at least a stopgap measure before the two companies’ capital buffer drops to zero at the end of the year pursuant to the terms of the Senior Preferred Stock Purchase Agreements (PSPAs) that govern the two companies’ relationship with the Treasury. He stated that it would

be a serious misconception for members of this Committee, or for anyone else, to consider any actions FHFA may take as conservator to avoid additional draws of taxpayer support either as interference with the prerogatives of Congress, as an effort to influence the outcome of housing finance reform, or as a step toward recap and release. FHFA’s actions would be taken solely to avoid a draw during conservatorship.

This signifies to me that he is planning on doing something other than reducing the capital buffer to $0.  As far as I can tell, Watt is playing a game of chicken with Congress — if you do not act, I will.

It is not clear to me clear how much authority Watt has or thinks he has to change the rules relating to the capital buffer. Does he think that he could act inconsistent with the PSPAa and withhold capital?  I have not seen a legal argument that says he could.  Is he willing to do it and be sued by Treasury?  These are speculative questions, but I do think that he has laid the groundwork for taking action if Congress and Treasury do not.

It does not seem to me that he was much wiggle room according to the terms of the PSPAs themselves, except perhaps to delay making the net worth sweep at the end of this year by converting it to an annual sweep or by some other mechanism.  That will be a short-term fix.

Given his strong language — “FHFA’s actions would be taken solely to avoid a draw during conservatorship” — I think he might be prepared to take an action that is inconsistent with the plain language of the PSPAs in order to act in a way that he thinks is consistent with his duty as the conservator.  This is less risky than it sounds because the only party that would seem to have standing to sue would be the Treasury, the counter-party to the PSPAs.  One could imagine that the Treasury would prefer to negotiate a response with the FHFA or await Watt’s departure rather than to have a judge decide the issue.  One could also imagine that Treasury would go along with the FHFA without explicitly condoning its actions, particularly if its actions soothed a turbulent market for Fannie and Freddie mortgage-backed securities.

Watt has consistently signaled that he will act if no other responsible party does and he emphasized that again today.

Time Is Ripe For GSE Reform

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Banker and Tradesman quoted me in Time Is Ripe For GSE Reform (behind a paywall). It opens,

Federal Housing Finance Agency (FHFA) Director Melvin L. Watt told the U.S. Senate Committee on Banking, Housing and Urban Affairs last month that “Congress urgently needs to act on housing finance reform” and bring Fannie Mae and Freddie Mac out of conservatorship after almost nine years.

Conservatorship is temporary by its very nature. There is universal agreement that it can’t go on forever, but there is widespread disagreement about what the government-sponsored entities (GSEs) should look like after coming out of conservatorship – and how to get there.

“Only a legislative solution can provide political legitimacy and long term market certainty for the housing finance system,” according to a recent Mortgage Bankers Association (MBA) white paper on GSE reform. MBA President and CEO Dave Stevens said now is the time for Congress to tackle the changes that will maintain liquidity, but protect taxpayers and homebuyers.

“The last recession destroyed many communities throughout the country,” he said. “The GSEs played a large role in that. They fueled a lot of the capital that allowed all varieties of lenders to make risky loans and then received the single-largest bailout in the history of this nation. They are not innocent.”

Connecticut Mortgage Bankers Association President Kevin Moran said his organization supports the positions of the MBA.

“There’s going to be change no matter what,” Stevens said. “We’re stuck with this problem. It’s technical and complicated and needs to be done. They can’t stay in conservatorship forever.”

Taxpayers Need Protection

Professor David Reiss at Brooklyn Law School said that future delays are not out of the question.

“Change is coming, but the Treasury and FHFA can amend the PSPA [agreement] again,” Reiss said. “It’s been amended three times already. There’s a little bit of political theatre going on here. It’s incredibly important for the economy. You really hope that the broad middle of the government can come to a compromise. If there isn’t the political will to move forward, they can simply kick the can down the road.”

Reiss said the fact that Fannie Mae and Freddie Mac are both going to run out of money by January 2018 is a factor in why reform is needed soon, but the GSEs aren’t in danger of imminent collapse.

“They are literally going to run out of money,” Reiss said. “But keep in mind they will continue to have a $2.5 billion line of credit. It’s partially political. They’re trying to get the public conscious of this. I don’t think anyone in the broad middle of the political establishment thinks it’s good that they’ve been in limbo for nine years.”
The MBA’s proposal to reform Fannie Mae and Freddie Mac aims to ensure that crashes like the one in 2007-2008 never happen again, in part by raising the minimum capital balance GSEs have to maintain to a level at least as high as banks and other lenders.

“They have a capital standard that is absurd,” Stevens said. “Pre-conservatorship they had to have less than 0.5 percent capital. Banks are required to maintain 4 percent of their loan value against mortgages. That’s a regulated standard. Fannie and Freddie are not as diversified as banks are. Our view is to make sure they are sustainable; they should at least a 4 to 5 percent buffer to protect them against failure.”

To put that into context, a 3.5 percent buffer would have been just large enough for the GSEs to weather the last housing crash without the need for a taxpayer-funded bailout. Stevens said the MBA would go even further.

“They should also pay a fee for every loan that goes into an insurance fund in the event all else fails,” he said. “In the event of a catastrophic failure, that would be the last barrier before having to rely on taxpayers. Keep in mind: for years, shareholders made billions and when they failed taxpayers took 100 percent of the losses.”

Stevens said the MBA would like to see more competition in the secondary market, and that the current duopoly isn’t much better than a monopoly.

“There should be more competitors,” he said. “If either one [Fannie or Freddie] fails, you almost have to bail them out. Our goal is to have a highly regulated industry to support the American finance system without using the portfolio to make bets on the marketplace.”

A Bipartisan Issue

While some conservatives like Chairman of the House Financial Services Committee Rep. Jeb Hensarling (R-Texas) have called for getting the government out of the mortgage business altogether, Stevens said that would likely mean the end of the 30-year, fixed-rate mortgage.

Furthermore, GSEs are required to serve underserved communities. Private companies would be more likely to back the most profitable loans.

“The GSEs play a really important role in counter-cyclical markets,” Stevens said. “When credit conditions shift, private money disappears. We saw that in 2007. It put extraordinary demands on Fannie Mae, Freddie Mac and Ginnie Mae. You need a continuous flow of capital. You can put controls in place so it can expand and contract when needed.”

Reiss said getting the government out of the mortgage business would certainly mean some big changes.

“I think there is some evidence that some 30-year, fixed-rate mortgages could still exist,” Reiss said. “It would dramatically change their availability, though. Interest rates would go up somewhere between one-half and 1 percent. Some people might like that because it reflects the actual risk of a residential mortgage, but it would also make housing more expensive.”

Framing Bipartisan Housing Finance Reform

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photo by Jan Tik

The Bipartisan Policy Center has issued A Framework for Improving Access and Affordability in a Reformed Housing Finance System. The brief was written by Michael Stegman who had served as the Obama Administration’s top advisor on housing policy. It opens,

With policymakers gearing up to reform the housing finance system, it is worth revisiting one of the issues that stymied negotiators in the reform effort of 2014: how to ensure adequate access to credit in the new system. The political landscape has changed substantially since 2014. For those who are focused on financing affordable housing and promoting access to mortgage credit, the status quo—the continued conservatorship of Fannie Mae and Freddie Mac—may no longer be as appealing as it was during those negotiations. This brief draws upon the lessons learned from that experience to outline a framework for bipartisan consensus in this transformed political environment.

The “middle-way” approach described here is not dependent upon any one structure or future role for the government-sponsored enterprises (GSEs), though it does assume the continuation of a government guarantee of qualified mortgage-backed securities (MBS). It is this guarantee that forms the basis of the obligation to ensure that the benefits flowing from the government backstop are as broadly available as possible, consistent with safety and soundness and taxpayer protection.

In recent months, at least three such proposals have been developed that preserve a federal backstop (see Mortgage Bankers Association, Bright and DeMarco, and Parrott et al. proposals). Should the administration and Congress pursue a strict privatization approach to reform, lacking a guarantee, it’s unlikely that any affordable housing obligations would be imposed in the reformed system. (cover page, footnotes omitted)

Stegman goes on to describe “The Affordable Housing Triad:”

Over the years, Congress has made it clear that the GSEs’ public purpose includes supporting the financing of affordable housing and promoting access to mortgage credit “throughout the nation, including central cities, rural areas, and underserved areas,” even if doing so involves earning “a reasonable economic return that may be less than the return earned on other activities.” As part of this mandate, policymakers have created a triad of affordable housing and credit access requirements:

  1. Meeting annual affordable-mortgage purchase goals set by the regulator;
  2. Paying an assessment on each dollar of new business to help capitalize two different affordable housing funds; and
  3. Developing and executing targeted duty-to-serve strategies, the purpose of which is to increase liquidity in market segments underserved by primary lenders and the GSEs, defined by both geography and housing types. (1, footnote omitted)

The paper outlines three bipartisan options that would not

compromise the obligation to provide liquidity to all corners of the market at the least possible cost, consistent with taxpayer protection and safety and soundness. Each option attempts to ensure that the system as a whole provides access and affordability at least as much as the existing system; includes an explicit and transparent fee on the outstanding balance of guaranteed MBS; and includes a duty to serve the broadest possible market. (3)

The paper is intended to spark further conversation about housing finance reform while advocating for the needs of low- and moderate-income households. I hope it succeeds in pushing Congress to focus on the details of what could be a bipartisan exit strategy from the endless GSE conservatorships.