An Undue Burden On Landlords

This column was written by David Freddoso.

But it might. If you're a responsible homeowner who doesn't plan to default on his mortgage, then changes proposed by House Ways and Means Chairman Charlie Rangel, D-N.Y., might mean that you'll pay more in taxes. And your higher taxes will "pay for" a tax break for those who do not make their payments and default.

Under current law, a foreclosure is treated as income - the bank is effectively giving you the difference between the foreclosure sale and the amount of the outstanding loan. If your home is foreclosed, you have to pay taxes on that amount, even though you never actually "get" anything. The House's subprime tax bill, which passed out of Rangel's committee yesterday, would end this - the "income" from a foreclosure would no longer be taxable at all.

Even if it appears to create an incentive for irresponsible borrowing, Rangel's tax cut for defaulters actually makes a good deal of sense. There is a strong argument against forcing a huge tax payment on someone who never actually sees any of that "income" as money - someone who probably defaulted because he is struggling and cannot make his home payments. If that were all it was, there probably wouldn't be any problem.

But it isn't that simple. The Democratic majority in both houses of Congress has imposed so-called "pay-go" rules on its budgeting process. This means that any action decreasing revenue from taxes on home foreclosures must be countered by a cut in spending or an offsetting tax increase. And you know how much Democrats love to cut spending.

So in order to pay for a defaulters' tax break, Rangel has to raise taxes somewhere. As his target, he picks small, independent landlords and owners of second homes.

People in these two groups may own two homes, but they are not necessarily wealthy. Their situation is not unusual either, considering that so many people jumped into the market during the housing boom and bought a second house, hoping that it would appreciate in value. According to the Metropolitan Regional Information System - a property tax database frequently used by realtors - there are more than 1.6 million absentee homeowners just in the Washington metropolitan region. The vast majority of these are independent landlords. I happen to own rental property myself in the Washington area, on which I lose a little money each month. Off the top of my head, I can think of several people in the same boat - my parents, a close friend and journalistic colleague, and at least two of my friends who work on Capitol Hill.

I meet later this week with another friend - not a rich fellow by any means - who is considering moving his family and renting out his home in suburban Virginia. He figures that instead of trying to sell into today's vicious market, he would do better to lease the place out for a few years and wait for market conditions to change. Many people who bought homes during the boom face the same dilemma - there has probably never been a time when it was so good an idea to lease one's home for a few years instead of selling it right away.

Currently, the tax rules for independent landlords are simple. If you live in your home for at least two out of the five years before you sell it, you get a large exemption ($250,000, or $500,000 for married couples) from the capital gains tax when you sell. This provision has provided a small encouragement for millions of people thinking about whether to buy. Along with a host of other market factors and tax incentives (the mortgage interest deduction, for example), this exemption has played no small part in the increase in American homeownership and wealth that we have seen over the last decade. It is also providing a three-year life raft for homeowners like the friend described above.

But Rangel wants to change that. Under his bill (H.R. 3648), the two-year/five-year exemption is scaled back, starting in January. If you rent out your home, any gain in home equity during that period becomes taxable. You are only exempt from paying capital gains taxes for appreciation you enjoy during the period when you actually live in your residence.

This change would negatively affect millions of homeowners. But Rangel's tax hike has received very little notice. Conservative Rep. Scott Garrett, R-N.J., who watches this issue carefully from a different angle in his seat on the House Banking Committee, was not personally familiar with it until I spoke with him yesterday. He did not like the sound of it.

"The whole idea of the existing law is obviously that it's beneficial to property value," said Garrett. "It encourages the investment and it encourages you to hold on to it. That increases the property value. But any time you tax the appreciation on it, you're hurting the property value."

Obviously, this provision hits the small landlord hardest. There is also a provision that will force large rental companies to withhold more in corporate taxes, but this will probably only hurt renters when costs are passed along in the form of higher rents.

It's one thing to give tax relief to those who are down and out. But in order to subsidize reckless borrowing, Rangel is raising taxes on the small landlords who actually pay their mortgages, and who are watching their home values fall in the current subprime mess. And it's all because of the pay-go rules.

That doesn't sound like much of a fix at all.
By David Freddoso
Reprinted with permission from National Review Online