Advertisement

YOUR TAXES : PART TWO: REAL ESTATE : Still no place like home for taxpayers : But reduced interest writeoffs are making ownership less appealing

March 15, 1987|PAUL RICHTER | Times Staff Writer

Homeownership will continue to offer the biggest tax deduction for which most Americans are eligible. But the new tax code reduces the value of mortgage interest deductions and includes new wrinkles that should cause many taxpayers to think through whether they should rent or buy a first or second home.

"The changes are going to make the choices tougher for a lot of people," said Andrew Harwood, tax partner in the Los Angeles office of Price Waterhouse & Co., the accounting firm. "They ought to really sit down with the old personal computer and try to figure out what their cash flow's going to look like over the next few years."

The declining value of home mortgage interest deductions can be simply illustrated. For a family in the 50% tax bracket, the after-tax interest expense of a $125,000, 10% mortgage under the old law was $6,250 a year, or $520.83 a month. As the family's bracket is reduced to 28% under the new law, the carrying cost rises to $9,000, or $750 a month.

"The government, in other words, is just carrying a lot less of the burden," said Pamela Pecarich, a partner in the national tax service of Coopers & Lybrand in Washington. "On the other hand, it's one of the few tax shelters left."

Homeownership still offers a handful of major advantages, in fact. Homes almost always appreciate, and homeowners don't have to pay tax on the proceeds of their sale, provided that they reinvest them in another principal residence within two years.

Taxpayers over 55 who want to cash in on their home won't be taxed on profits up to $125,000. Interest on home equity loans is still deductible--a fact that has set off a lender's stampede to offer such loans to consumers.

Also, many people simply like the psychological satisfactions of knowing they own their home and aren't subject to the decisions of landlords. Nearly two-thirds of American families now own their homes, and real estate experts don't expect that percentage to decline much because of the changes in the tax treatment of homes.

The real estate industry lobbied hard as the tax bill was written to get across the notion that declining real estate writeoffs may discourage the construction of new rental housing and cause rents to rise as investors look for ways to offset their dwindling returns. Some have predicted rent increases of as much as 20% over the next several years.

But some tax experts caution that taxpayers debating whether to rent or buy should not be stampeded into buying because of such forecasts. In many markets, the upward pressure on rents from such changes will be far less important in setting rents than the general forces of supply and demand.

Some believe that many rents have already been increased in anticipation of real estate's declining writeoff value. And, Harwood said, such forecasts may prove less accurate than they seem. "If you make a big decision because of some macroeconomic forecast, you may regret it," he said.

Indeed, he said, many taxpayers may find sound economic reasons for renting. Some taxpayers who have been nearly unable to carry a mortgage will now find themselves simply unable to afford one.

"For people who relied on the tax benefit to help them with a limited cash flow, now renting may be a better idea," Harwood said.

And others, particularly in overbuilt areas of the country such as Texas, Louisiana and Florida, will discover that they can do far better in the rental market, assuming that rents are low and appreciation prospects are not good.

A family who has sold a house and moved to an area with low rents may not wish to rent for long, however. If the period of rental is more than two years, the profit from the home's sale will become taxable.

Real estate experts expect the reduction in the federal subsidy of homeownership to have wide effects on the market for principal residences. Upper-income families will be hardest hit by the tax law changes, for their deductions will suffer the greatest reduction under the new law.

Many upper-income families who have been stretching their finances to afford a bigger house are expected to choose smaller houses--a trend that some predict will sharply constrict the market for larger homes.

The new tax also involves important changes in the treatment of second homes.

The mortgage interest on a second home is still deductible--though, again, at a lower rate because of the general lowering of tax rates. The law also now stretches out the depreciation period to 27 1/2 years from the former 19 years.

The law shouldn't have much effect on a taxpayer's decision to buy a second home if it is to be entirely for personal use. But the rules are changed dramatically for those who want to rent out their second home and deduct losses against their income.

Advertisement
Los Angeles Times Articles
|
|
|