Monday, January 14, 2013

Real Estate's Temporary Reprieve with Fiscal Cliff Legislation



The threat of falling off the fiscal cliff has been averted for 2013 -- Or at least, the consequences that could have triggered wide-spread recession. The real estate industry received a reprieve through extension of key components of the American Taxpayers Relief Act of 2012 signed on January 1st of this year.  A major concern was the Mortgage debt forgiveness rule that ensures that lender losses through short sales, foreclosures and principal reductions dont end up as taxable capital gains for distressed homeowners was extended for yet another year, along with the private mortgage insurance (PMI) income tax deduction. On the flip side, expiration of Bush-era tax cuts and a 5% hike on top marginal tax rate for capital gains have many investors evaluating their options for 2013, along with weighing the consequences of a new 3.8% tax on investment income to subsidize health care reform.  In addition the state tax rate and new associated taxes have increased further creating a chilling effect on contemplated real estate investments. Opportunities do exist for both consumers and investors in this post-cliff” cycle, but it requires a different perspective to make the most of them. I feel comfortable saying that the momentum will continue to be favorable due to the cliff avoidance unless further unknown developments take us down.

Allowing the Mortgage Debt Relief Act to expire would have signaled the beginning of the end for the housing’s recovery, and it was a prudent choice on the part of lawmakers to extend it. The impact of short sales on helping lenders and servicers cure their non-performing asset problem more than proved itself in 2012, and the extension serves to continue that momentum. Both distressed homeowners and lenders win. And, by allowing the deduction for PMI to continue through the end of 2013, first-time buyers without the traditional 20% for a down payment receive some relief from the additional premium MI adds to their mortgage. With 46% of first-time buyers utilizing FHA loans with mandatory MI in place during 2012, there are widespread effects of the deduction. In light of still-constrained underwriting standards for conventional loans, originators have found a way to offer mortgages to borrowers that don’t meet their minimum criteria through FHA-backed loans. In this case, first-time homeowners and lenders benefit.

Opportunities for investors in 2013 may seem a bit more elusive. Anticipating changes in the capital gains taxes this year, many investors that didn’t take a wait and see” stance scurried to finalize transactions by the end of 2012. Those wishing to take advantage of opportunities in 2013 still have options at their disposal. Smart investors will embrace the benefits of the 1031 Exchange process that allows an investor to sell a property and to reinvest the proceeds in a new property as a way of deferring all capital gain taxes. The 3.8% Medicare tax from the investor perspective will have significant ramifications as the investment income qualification includes net gains from property held by investments.  While most homeowners will escape taxation on the sale of personal residences under the new law, investors that decided to wait for the fiscal cliff dust to settle may find the tax implications of real estate deals play a larger role in evaluating short and long term returns.  Deferring taxes should be part of the overall strategy and should be good news to the qualified 1031 intermediaries.

2013 may also bring new opportunities for investors in the bulk sales arena. The FHA, reeling from losses of vintage pre-2009 loan guarantees, has embraced distressed note sales as one of its strategies to remain solvent. Bank of America is shedding billions in mortgage servicing rights and through auctions of toxic assets acquired from its ill-fated Countrywide acquisition. Investors have found a new asset class in bulk purchases to fuel the newest REO-to-rentals market. While housing inventory at the consumer level is still constrained and driving up home values, bulk sales available to the investor class is developing as a new sector for 2013. This was being handled internally with a very limited number of qualified investment funds and not really open to a large class of smaller investors. Perhaps this year, they will open it up. 

While stopgap measures signed into law on January 1st extended consumer relief without a major disruption in investor activities, the jury is still out on the long-term consequences changes in taxation will have on the industry’s momentum achieved in 2012. The tougher decisions on debt ceiling and program cuts still lie ahead that now may have greater implications for the economy. Now that weve taken a few steps away from the edge of the cliff, the real estate industry can take a breather --- for now.

2 comments:

  1. Well that’s great post, keep it up I really like your view’s being greater implications for the economy I totally agreed on this point.

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  2. Gil, you’re right that investors must be smart in this financial climate and take advantage of 1031 exchanges. They provide deferment in capital gains tax, giving millions of homeowners that much-needed financial breathing space. It's just that we still have to publicize 1031 exchanges so that more people will benefit from its rewards.
    Rhonda Dean @ 1031Company.com

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