The Homa Files

Some history
In the old days, investors would snatch foreclosed properties at bargain basement prices, rent them out for a couple of years, and bag the profits — paying taxes at capital gains rates.  Housing prices were increasing at a slow steady rate, but that was good enough.  Why? Ordinary income tax rates were high relative to capital gains rates, and gains on the sale of rental property were capital gains.  Investors could deduct depreciation when they owned and rented the property — creating a tax loss that could be applied to ordinary income. In effect, the investors were arbitraging the ordinary income tax rate against the capital gains rates,

Fast forward
Today, there are plenty of cheap properties on the market (think foreclosures).  Why aren’t investors snatching them up?  Well, in part because they fear the housing market hasn’t bottomed out, and in part because the tax laws aren’t as favorable as they used to be.

What happened?  Well, the “paper losses” from depreciation lost some value when rules were established to limit so-called “passive losses”. Then, ordinary income tax rates were slashed, narrowing the gap between ordinary income and capital gains rates.  The incentives to buy and rent property diminished.  Now, Obama plans to raise capital gains rates MORE than ordinary income rates — further diminishing the tax advantages of buying and renting.

The opportunity
Imagine a flood of private capital swooping in to buy distressed residential properties at current market values.  The benefits: takes properties off the market (for awhile) and potentially bids prices up (a little).  After the market stabilizes, the properties “naturally” flow back onto the market at an orderly pace.

How to do it

(1) Allow very accelerated depreciation on rental properties — say, 10 years — to increase the “paper” tax losses

(2) Eliminate passive loss limitations on residential rental property — allowing unlimited rental property losses to be applied to ordinary income (and carried forward, if necessary)

(3) Cut the capital gains tax rate to ZERO on residential property purchased after, say, November 15, 2008 — re-establishing the incentives for investors to buy, rent, and sell

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This entry was posted on November 18, 2008 at 8:00 am and is filed under Financial Crisis, Mortgage Crisis. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.