New Legislation Could Hurt The Second Home Market.

The Ways and Means Committee approved a bill which restricts homeowners' ability to avoid or reduce the taxes on the sale of second homes.

The Ways and Means Committee, the House's tax-writing panel, approved a bill yesterday under which homeowners facing foreclosure won't get stuck with a tax bill if part of their debt is forgiven by lenders. Currently, forgiven debt is treated as income to the borrower and is subject to tax.

The committee decided to pay for the tax break, as required by congressional budget rules, by restricting homeowners' ability to avoid or reduce the taxes on the sale of second homes. The gain in revenue would be equal to roughly $2 billion over 10 years.

Under current law, a person can exclude from taxes up to $250,000 in capital gains on the sale of a principal residence. Up to $500,000 of gains can be excluded for married couples. A second home can become a principal residence as long as the taxpayer has lived there for two of the previous five years.

• Under the new legislation, the size of the tax break for a second home would be tied to the portion of time, out of all the years a house is owned, that it serves as a principal residence. Living in a property longer would result in a larger tax break on any gains when it is sold.
• Both the Mortgage Bankers Association and the National Association of Realtors supported the overall bill.

White House Administration objects to tax hike on second-home sales

The Bush administration is seeking to narrow the scope of a bill that would give homeowners facing foreclosure a tax break when lenders forgive part of their debt.

The administration supports a provision of the bill that would amend a section of the tax code that allows the IRS to tax as income any debt that's forgiven in a foreclosure sale, or when mortgage lenders agree to modify loan terms or allow short sales.

But the change to the tax code should only be temporary, the administration said Tuesday, "to avoid distorting consumer and lender decisions on new mortgage loans" after mortgage markets emerge from the current "transition period."

"The tax code already protects people who are insolvent or whose debt has been discharged in bankruptcy from having to pay tax when debt is cancelled; therefore, the most financially stressed mortgage borrowers are already protected under current law," the administration said in a policy statement. The White House said it "looks forward to working with Congress to narrow the scope of the bill and ensure that it addresses current difficulties without the potential for influencing future behavior."

The bill -- HR 3648, the Mortgage Forgiveness Debt Relief Act of 2007 -- received unanimous approval Sept. 26 from the House Committee on Ways and Means, and is scheduled for a House vote Thursday.

The administration said it also objects to a provision of the bill that would make up for the expected lost tax revenue by tightening the rules for counting a second home, vacation or rental property as a primary residence for tax purposes.

Under current law, married couples can claim a deduction of up to $500,000 on gains from the sale of a primary residence, and can count a second home as a primary residence if they lived there two of the five years before the sale.

By tying the size of the exemption to the actual number of years a second home is used as a principal residence, the bill would raise an estimated $2 billion in additional taxes during the next 10 years.

The tighter restrictions on claiming a second home as a primary residence are intended to offset the estimated $1.38 billion reduction in tax revenue over the next 10 years if forgiven debt is no longer counted as income. HR 3648 would also extend the new deduction for private mortgage insurance to 2014 at a cost of $570 million over 10 years.