Friday, August 05, 2005

A Call To End Tax Free Gains On Real Estate

I came across an article on this morning by a Business Week writer who is complaining about the $250,000 to $500,000 tax free gains policy the IRS provides when selling a residence. (If you aren't aware, you can sell you house and keep up to $250,000 of gains tax free if you are single, or up to $500,000 of gains if you are married. You must have lived in the property for 2 of the last 5 years to qualify for this.) Basically, he is saying this skews investments away from businesses and into real estate and encourages people to move every 2 years. His complaint is that other investments, such as stocks, are subject to a 15% capital gains tax and he doesn't see why selling a home should be any different. The article sounds like sour grapes from a stock investor.

The author states "The powerful lure of tax-free profit is one reason that home prices have risen at a nearly 7% annual rate, vs. about 4% for the stock market since 1997." Although he mentions it briefly, he dismisses all-time low interest rates as a major factor (perhaps the major factor) in the real estate boom and instead seems to think everyone is buying a new home every 2 years solely for the tax benefit. He also misses the boat in assuming it is owner-occupants (the only ones eligible for this tax break) who are driving up the housing market. What I believe is really happening is investors are buying houses for rentals, not to live in. Turning a profit on these investments is pretty easy, given low interest rates. That is what is inflating the price of a house.

Had he really understood real estate investing, rather than railing against the tax break on the sale of a primary residence, he would instead be railing against the tax advantages of the 1031 exchange, which allows investors to defer capital gains tax on income property indefinitely.

Finally, he states "
As much as possible, the tax code shouldn't bias investment decisions." On the contrary, the tax code is expressly designed to bias investments toward what the government believes people should be investing in. Take, for example, all the tax benefits of owning a small business. The government wants businesses created so that more jobs can be made, jobs from which the government collects payroll taxes. The tax code encourages investment in real estate so that a healthy housing market is maintained and the government does not have to provide shelter for millions of people.


Steve said...

I haven't read the article yet, but there is a H-U-G-E difference between real estate and stocks - habitation. While I see his point about tax codes being somewhat favoring real estate investmenting over stocks (or other "paper" investing), real estate is used not only as an investment but moreso as a place to live (or work). The government give breaks in this way to induce home ownership. If he's sour about this, he should REALLY be sour about the government giving monetary incentives to agricultural and livestock owners/businesses.

Richard said...

Who ever is investing in stocks and only takes 4% really needs to find another investment vehicle. He or she does not understand Paper investments enough. why @ 4% , Inflation and Taxes will have you funding your portfolio forever. Education in all things is essential. Even if you want to weave baskets.

jim said...

An even bigger difference than habitation is transaction costs - both in terms of money and time. If you want to buy a stock, you hop online to your brokerage account, type in the ticker, click buy. You want to sell? Do the same as buying, except you click sell.

While I'm not a real estate investor, I think there may be a *little* more work involved when buying and selling real estate. :)

Jonathan said...

"As much as possible, the tax code shouldn't bias investment decisions."

I completely agree with you here. The tax code is totally designed to do this, from 100 different angles. I'd say accept it and play within the rules. I know someone who's parents do move every two years though (He's a carpenter and can fix up stuff nice). She hates it. I would too...

tmtb said...

Is he jealous? I'm not in REI, but in business building. It's the equivalent of people who say that big business does not pay it's fair share of taxes and the working stiff carries it all. Businesses, and investments fuel the economy. If they don't get the tax breaks, there will be no working stiffs. Amazing!

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