Is that House Really Worth That Much?

Even though new federal rules prohibit appraisers, realtors, and individual home sellers from tweaking home values higher, an article by Kenneth Harney in last Sunday's Chronicle implies that inflated appraisals are still the norm. 

The housing boom came into being in large part because of a faulty appraisal system--one in which the people selling or providing capital (those who stood to make the most profit) had the most control over price tags. This system resulted in skewed home values that influenced prices everywhere. The most pressure on appraisers comes from lenders, who want to make sure home values will be set at a price that limits their losses. New laws threaten severe punishments for appraisers who buckle---in some states they can lose their licenses, and the secretary of housing can even impose financial penalties on appraisers found guilty of inflating values.  

Kenneth Harney San Francisco Chronicle Article: Appraisers Still Getting Pressure on Prices

Taxes, Taxes, Taxes--What the New Housing Bill Means

Until the new housing bill came along, couples selling their first homes weren't taxed on the initial $500,000 (singles escaped taxation on $250,000) of their profit as long as the property was their primary residence for at least two of the five years before the sale. 

A lot of people took advantage of this by selling their first home and moving into an investment or vacation house for two years and then repeating the process. In places where the housing bubble sent home values through the roof, savvy sellers pocketed the first half a million of their profit completely tax-free. 

Tax reformers spotted the loophole and have designed the new housing bill to tighten taxes, with the intention of bringing in over 1.4 billion dollars in tax revenue throughout the coming years. 

Here are the new rules, as outlined by Kenneth Harney of the Washington Post in an article (I found it in The San Jose Mercury News) called Exclusion on sale of 2nd Homes Reduced--

"If you buy a second home or investment property on or after Jan. 1, convert it later into your principle residence and then sell, you'll need to allocate any gain from the sale between periods of qualified and non-qualified usage.

The minimum period for qualified principal residence use will remain as under the current law-- two years out of the five preceding the sale.

Sellers in future years will need to create a fraction against which to multiply their total gain. The numerator will be the time period the house was used as something other than a principal residence. The denominator will be the total period of ownership."

Harney gives a good example that'll be clearer than anything I can sum up--

"Say you're a single taxpayer and you buy a house Jan 1st for $400,000. You rent it out for two years and write off $20,000 in depreciation deductions. Then on Jan. 1 2011 you decide to convert the rental house into your principal residence. You live there for two years. On Jan 1 2013 you move out and put the place up for sale. On Jan 1 2014 you complete the sale of the house for $700,000. 

As under current law, the $20,000 of depreciation write-offs is treated as gross income. The two years of use as a principal residence qualifies you for some amount of tax-free exclusion on the $300,000. But how much?

To figure it out, you dived your aggregate period of non-qualifed use (the two rental years) by your total period of ownership (five years) and multiply that fraction ( 2/4 or 40%) against your total gain of $300,000. The resulting number is the amount that's subject to capital gains taxation--$120,000 in this case. But the remaining $180,000 is tax free."

Buy Now. Or at Least Before June 30th 2009

Buying a house is always a big decision. Especially if you've never owned one before, and especially when the housing market is unstable. Anyone who's been trying to wait out the storm should check out the new home purchase tax credit created by the massive housing bill Congress just approved--for some buyers, it may make the decision seem a whole lot easier.  

According to Kenneth Harney in a recent San Francisco Chronicle article called How Home Purchase Federal Tax Works, first-time buyers and buyers who haven't owned a house within three years may be eligible for up to a $7500 credit against their federal taxes for 2008 or 2009. They are only eligible for the credit if they go into closing on their home before the end of June, 2009. 

High expectations surround this new home purchase tax credit. In theory, it seems like it could work wonders. Congress has set no limit on the number of people who can qualify, and the credit should work to kick housing sales back up while finally clearing out unsold real estate inventories across the country. There are no regulations on the kind of house. It can be any price, in any location, old, new, with five bathrooms or one and a half.  As long as the buyers fit the profile and it's in closing before June, 30, viola! Your tax bill will be up to $7500 lighter. 

If you owe the IRS any money from income taxes, the credit could wipe out what you owe and grant you a hefty refund. Harney writes, "The new home purchase tax credit is what the government calls refundable: If your tax bill is less than the credit amount, you get the difference back from the Treasury."

Current home owners are not eligible for the credit. It applies only to first time buyers, or people who sold their homes more than three years ago and now rent. High earning buyers (with adjusted gross incomes over $150,000) will see their credit maximum scaled down in increments. 

There is a payback, however. Beneficiaries of the tax credit are required to pay the credit back over a number of years, even as many as 15. If you sell the house before your repayment period is up, you won't have to pay the credit from the proceeds. Harney writes, "In other words, the federal government is taking on all or much of the risk that the value of your new house won't increase over time." 

Think of it as a loan, albeit an interest free one. And you can only take out $7500. 

HOPE

A recent article in the Mercury News lays out the future for the HOPE program, and what struggling mortgage borrowers can expect from this $300 billion dollar initiative.  For the full article, click the link--

Kenneth Harney: There's 'HOPE' around corner for struggling mortgage borrowers

The basic goal behind the HOPE program is to save people at immediate risk of losing their houses who could afford to keep their property and avoid foreclosure if offered a reduction in mortgage balances and interest rates. 

The program as outlined is completely voluntary, and that may be one of its biggest flaws. It's supposed to provide refinancing to as many as 400,000 homeowners drowning in their current loans, but it will ultimately be up to the lenders and investors who own those loans to decide if they'll allow their borrowers to refinance. So even if the borrower desperately wants or needs to take advantage of the HOPE program their lender might stop them, fearing they'll lose less by letting borrowers slide into foreclosure. 

This puts a massive roadblock in place that may severely limit the HOPE program's ability to actually help homeowners. There are other hurdles to consider as well. Here they are, straight from the article. 

Borrowers must--

"Demonstrate a "lack of capacity" to pay their current mortgage but have enough income to make regular monthly payments on a smaller, fixed-rate FHA loan. Their current income-to-mortgage debt ratio must be above 35%.

Certify to the government that they haven't "intentionally defaulted" on their current mortgage or on any other debt in order to refinance into a HOPE loan. They must also certify that they are telling the truth about their financial status, and have never been convicted of a fraud. Anyone who lies will be subject to severe penalties, including up to five years in prison.

Agree to use and occupy the refinanced house as their principle residence, and not own any additional houses."

The plan could go into effect as early as Oct 1st. Hopefully it will help shovel us out of the housing/foreclosure crisis. We'll have to wait and see how cumbersome the limitations on this program prove to be.