Housing And The IRS (August 27, 2007)

Taking the first of what may be a dozen steps to address the housing collapse cannot be done until the extent of the addiction is admitted.  Looking up and around and conceding the truth might create panic.  The monthly mortgage payments must be made this month, and next month, and next month, and next month, and next month, and next month, and next month, . . . . . . . . . . . . and then they are adjusted upwards and must be paid the next month, and next month, and next month, and next month, and next month, and next month . . . . . . . .  and yet there is little money to make the payments.  There are no easy solutions.

The Internal Revenue Code should be amended to eliminate the tax on debt forgiveness.  Few taxpayers realize that a debt forgiven either by the action of the creditor or a foreclosure or the like is still considered taxable income by the IRS.  The New York Times recently ran an article discussing the tax provision and its consequences for taxpayers who have lost their homes.  Individuals either must file bankruptcy at the right time or prove insolvency.  Eliminating the tax would perforce reduce tax revenue, although the provision is not taxing what most individuals generally and reasonably regard as income.

Pursuant to section 121 of the Internal Revenue Code, if a taxpayer lived in a “principal residence” for two out of the five year period before it is sold, the taxpayer can exclude up to $500,000 of gain if married and filing a joint return or up to $250,000 of gain if filing a separate tax return.  There should be some consideration to changing the residency requirement to five out of the ten year period before the residence is sold.

The mortgage interest deduction is the last major tax relief for the middle class.  The interest deduction for other consumer purchases was eliminated years ago.  Taxpayers simply refinanced their homes, used the funds for consumer purchases and took one obese mortgage interest deduction.  (See the e-ssay dated February 7, 2005 entitled “The Microeconomics of Suburban Subsistence”).  The deduction phases out at higher income levels.  Revisiting and fine tuning the deduction seems prudent.

These suggestions are not adequate.  There are no easy solutions.

Bumper sticker of the week:

It will get worse

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