Fiscal Fitness

Courtesy of Frederick Peters, President of Warburg Realty

Will we drive over the fiscal cliff? Whether we do or not taxes and tax breaks are likely to be reconfigured in 2013. So what are the implications for real estate of going over the cliff? And which tax breaks will be the worst for our business (and our world at large) to lose?

I believe 2013 will be a strong year for New York real estate regardless of what the government finally decides to do about spending and revenue. But I do think a plunge off the fiscal cliff will negatively impact our first quarter. On the one hand, business and employment numbers are both improving, and Congress’s inability to resolve its financial plans before December 31 is unlikely to change that. On the other hand, beginning the New Year with no financial plan in place will almost certainly destabilize the stock market, and real estate buyers are far less likely to act when that market is jumpy. By the end of the first quarter the financial issues will almost certainly be headed towards resolution, stocks will calm down, and real estate buyers will relax and remember that THIS is why people buy real estate in the first place. It’s a good hedge against volatility.

So then we will face the question of HOW the need to raise revenue will be addressed. Of all the proposals on the table, the one with the biggest impact is the one we hear the least about: the loss of Federal deductibility of state and local taxes. While not specifically targeted at real estate, this deduction, if lost, will have enormous impact on the tax bill of most New Yorkers, since our state and local tax rates are so high. We should all be calling our representatives in Congress trying to head this one off at the pass.

There is a lot of talk in real estate circles about the mortgage deduction, about which I wrote a couple of weeks back. Honestly I do not think some scaling back in the mortgage deduction will be that impactful for the New York real estate marketplace. First, with interest rates so low, the deduction just doesn’t amount to that much money anyway. If the government was to roll back the size of a deductible mortgage from $1,000,000 to $500,000, the net cost to those with $1,000,000 mortgages would be under $10,000. Similarly, the loss of the ability to deduct mortgages on a second home, while an inconvenience to many (myself included), is not really a game changer. After all, it would only affect those who can afford second homes!

Finally, there is the anticipated increase in the capital gains tax. This will, in my opinion, have a negative impact on the supply side of our market. Our capital gains taxes in New York City are already the highest in the country, with about 12.5% of state and local taxes over and above the 15% top Federal rate. With a 5% increase in the top rate, plus the new 3.8% tax on investment income levied on high earners to pay for health care, some owners and investors could be paying above 35% on their appreciated assets. My prediction: during 2013, until individuals become accustomed to the changes, owners of large properties, with large embedded capital gains, simply won’t sell. They will shut the doors to a few of their bedrooms and stay put.

So this is how I see it – some changes in the mortgage deduction would not do much harm to our market. Loss of the deduction on state and local taxes at the Federal level would be a tax disaster for our state in general and our city in particular. And an increase in the capital gains tax rate will shrink our already inadequate supply of large properties, which will add to the gridlock already in place: the owners of 4 bedroom properties don’t move, so there is less for the buyers who own 3 bedrooms to buy. So they stay put, which leaves less for the people in 2 bedroom apartments to buy. And so on… The tight supply will keep the market strong and fast, even if it is temporarily slowed by volatility in stocks if the automatic tax increases and spending cuts go into effect January 1. No matter what, the events of the next month will tell us a lot about what to expect in the year ahead.

You can read more on www.warburgrealty.com/blog.