Gretchen Morgenson had another dreadful column this weekend: the housing “nightmare grows darker,” according to the headline, but Morgenson adduces not a single piece of evidence to that effect.
If Morgenson wanted to find real reasons for worry, as opposed to inchoate doom-mongering, she could have done a lot worse than reading Bill Bischoff’s Smart Money article on the taxes people owe when they sell their homes.
In the olden days, things were simple. You took out a mortgage to buy a house, and then when you sold your house it had either gone up in value or it hadn’t. If it had, then you made money on the sale, which was a taxable capital gain. If it hadn’t, then you didn’t have a capital gain, and didn’t have to pay any tax.
Nowadays, thanks to the rise in home-equity extraction, things are very different.
Say you paid $260,000 for a home that you can now sell for a net sale price of $300,000. Unfortunately, you also have $350,000 of first and second mortgages against the property. For tax purposes, you’ll have a $40,000 gain if you sell, because the sale price exceeds your tax basis in the home ($300,000 sale price – $260,000 basis = $40,000 gain). The IRS doesn’t care that you’re still $50,000 in the red after the sale ($350,000 of debt vs. the $300,000 sale price). The bottom line is you can have a tax gain without actually having any cash to show for it.
Alternatively, what happens if your mortgage company forgives some of the debt you owe them? It’s not good news from a tax perspective: any money written off by your creditors is “debt discharge income”, which has to be reported as income on your tax return.
Let’s say you buy a house with zero money down for $250,000, you sell it for $200,000, and you find another $10,000 to settle up with the mortgage company. For tax purposes, you’ve just made $40,000 in income – which you need to pay tax on. Ouch.
There’s a lot of muttering in Washington about legislation to reign in predatory subprime lenders. (And yes, you’d be right in thinking that that horse bolted long ago.) Much more useful would be legislation to reduce the income-tax consequences of short sales.