WASHINGTON -- Could the popular $250,000-$500,000 tax-free exclusion of capital gains on sales of homes be a target in any broad-scale, post-election effort to reduce the federal debt and deficit?
Absolutely. Though far more public attention has been given to the presidential candidates' proposals for reining in the mortgage interest deduction, the capital gains exclusion is one of a number of housing "preferences" -- subsidies -- embedded in the tax code that are on the table in fiscal negotiations beginning later this month on Capitol Hill and likely extending well into 2013.
Nonpartisan, corporate-backed groups such as Fix the Debt, which has nearly 100 CEOs of blue-chip companies such as GE, Dow Chemical, AT&T and Microsoft on its list of supporters, define the report of President Obama's deficit reduction commission as the starting "framework" for their forthcoming national debt-reduction campaign. The deficit commission, headed by former Wyoming Republican Sen. Alan Simpson and Erskine Bowles, White House chief of staff for Bill Clinton, called for eliminating or restricting most current tax deductions as part of a plan to reduce the federal deficit by $4 trillion by 2020. The commission also envisioned deep cuts in federal spending and a reduction in corporate and personal income tax rates.
Though the commission carved out one possible exception for housing -- converting the mortgage interest deduction to a 15 percent tax credit -- tax experts say that under the Simpson-Bowles version of fiscal reform, virtually all real estate write-offs, including the capital gains exclusion, would disappear in a vastly simplified federal tax code. Others on the list: deductions for local and state property taxes; federal tax exemption for interest on state government bond issues used to help provide mortgages for moderate-income home purchasers; and exemption for income taxation of mortgage amounts forgiven by lenders in loan modifications and short sales.
The exclusion of home sale profits, which is projected to save homeowners $86 billion between 2010 and 2014 according to congressional tax estimates, allows taxpayers who have owned and used their principal residences for two years out of the five years preceding a sale to escape capital gains taxation on as much as the first $250,000 (for single filers) and $500,000 (married joint filers) of the profits they make from the transactions.
The ability to pocket home sale gains without taxation is available to all qualified owners once every two years. But it is of special importance to pre-retirees and retired owners as it allows many of them to owe no federal taxes on their home sale gains -- most sales do not generate anywhere near the $250,000 or $500,000 threshold limits -- and to factor this tax-free money into planning for their retirement years. A Pew Research Center study released Oct. 22 found that growing numbers of American adults are worried about having enough money for retirement -- nearly 40 percent describe themselves as being in this category, up from 25 percent in a similar study in 2009. Though families' real estate equity holdings were hit hard by the recession and housing bust, Americans still have approximately $7.3 trillion available to them, according to the latest Federal Reserve quarterly study.
In a so-called "grand bargain" comprehensive reform plan based on the Simpson-Bowles framework, as advocated by Fix the Debt, owners might pay ordinary income taxes at a lower rate but could also lose valuable preferences built into the tax code over a period of decades that were designed to encourage ownership of a home. Whether the net financial benefits of the lower tax brackets would outweigh owners' loss of deductions for mortgage interest and other current advantages -- including tax-free treatment of gains on sales of their homes -- would depend on the specifics of the grand bargain, phase-in timetables for the tax code changes, and on each owner's personal situation.
Bottom line here: Almost no one opposes the concept of reducing the federal deficit. But how this is achieved -- who gets hurt, who benefits -- will be key. During the coming lame-duck congressional session and into the new Congress, a variety of plans are expected to surface, some cutting spending drastically, others claiming to straighten out the tax code by ridding it of special preferences for individuals while lowering rates for big corporations.
If you own a home, keep your eye on the tax deduction ball. The largest single tax-free benefit most owners will ever receive from the federal government could be in play.
Ken Harney's email address is email@example.com.Copyright 2012 Washington Post Writers Group