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The Coming Housing ‘Fiscal Cliff’

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Most Americans have heard of the “fiscal cliff.” The term — first used last year by Federal Reserve chairman Ben Bernanke — refers to the economic disaster that awaits Americans if tax increases, spending cuts and budget deficit rules go into effect starting January 2013 if the Democrats and Republicans on Capitol Hill can’t come to an agreement in three weeks.

But while the fiscal cliff scenario threatens to derail the U.S. economy as a whole, real estate is teetering on its own fiscal cliff. Here are four areas of concern.

No. 1: Increase in Capital-Gains Tax
The White House wants “the rich” to pay more taxes. Republicans are opposed to any increases in taxes. But if the Bush tax cuts are allowed to expire, capital-gains tax rates will go up as of January 1, meaning anyone who sells their home could owe more on those sales. As a result, many sellers are racing to close before 2013. If the Bush tax cuts are allowed to expire, the current capital-gains tax of 15 percent will rise to 20 percent. Plus, the new federal health-care tax of 3.8 percent on investment income also kicks in next year for couples who make $250,000 or more. The combined tax-hiking impact of the Bush tax cuts ending and the looming 3.8 percent Medicare surtax have been dubbed Taxmageddon.

Capital-gains rates could remain unchanged if a deal gets done in Washington. But don’t count  on it.

No. 2: Expiration of Mortgage Interest Deduction
The mortgage interest deduction — long considered the centerpiece of American homeownership — is on the chopping block. Presently, interest on loans up to $1 million can be deducted on primary and secondary homes. Be prepared for this  Holy Grail of housing to either be eliminated or scaled back considerably.

No. 3: Expiration of Mortgage Debt Forgiveness Act
Short sellers could be in for a big surprise come January 2013, if the Mortgage Debt Forgiveness Act expires. If this law perishes, short sellers will be taxed on unpaid mortgage debt, which the IRS considers taxable income.

If this law dies, thousands of distressed borrowers will avoid short sales (because of the tax hit) and simply walk away from their underwater homes, sending foreclosure filings upward in 2013. Moreover, home sales would decrease nationwide, putting downward pressure on home prices.

No. 4: Bailout of Federal Housing Administration
The Federal Housing Administration is nearly insolvent and it could require a taxpayer bailout next year, according Edward J. Pinto, a fellow at the American Enterprise Institute. Pinto claims the 78-year-old agency is $34.5 billion short of its legal capital requirement.

“If it were a private company, it would be shut down,” argues Pinto.

These aren’t the only issues threatening the real estate market. Since Fannie Mae and Freddie Mac were taken over by the government in 2008, taxpayers have plowed  $180 billion into them to keep them operational. This mess needs to be fixed next year.

And mortgage insurance could be eliminated too.

What are your thoughts? Is a real estate fiscal cliff coming?

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