Quantifying Cumulative Government Kickbacks for Homebuyers

I thought it might be useful to visualize just how much the government is involved in the housing market. Let’s look at how much a homebuyer receives via capital gains tax excemption for home sales, mortgage interest deduction, deductability of points paid on mortgage, and first-time buyers tax credit over 5 years, 15 years, and 30 years.

Here are the underlying assumptions I’ll be working from: $400,000 house, $1,600 / mo rent. 3% YOY home value appreciation, rent increases 2% YOY. Buyers are a married couple with good credit in 25% tax bracket. Home maintenance costs average 1% of purchase price per year. Utilities are equal between rented house and purchased house. No HOA dues. 3.5% down, 1 point paid on FHA 30-year fixed financing for an APR of 5.489%.

Scenario 1: Buy a house, stay in it for the duration of the mortgage, paying it off in 30 years.

Scenario 2: Buy a house, in 5 years, sell house and move to roughly equivalent house, putting down whatever extra money remains from the sale. Repeat every 5 years for 30 years.

Scenario 3: (baseline comparison) Rent for 30 years.

Here’s what the outlays and kickbacks look like for each scenario after 5 years (that’s one sale by the 5-year buyer):

Government Kickbacks for Home Buyers

Both the 30-year buyer (scenario 1) and the 5-year serial buyer (scenario 2) received the $8,000 tax credit and saved $17,997 in income taxes. The 5-year serial buyer saved an additional $4,081 in capital gains tax exemption.

Here’s what it looks like after 15 years (3 sales by the 5-year buyer):

Government Kickbacks for Home Buyers

Since the 5-year serial buyer reset their mortgage interest amortization at 30 years three times, they have now saved $57,015 in income taxes vs. the 30-year buyer’s $23,799 savings. The 5-year serial buyer has also saved $12,878 with capital gains tax exemptions on three sales.

It gets even more lopsided after 30 years:

Government Kickbacks for Home Buyers

The 5-year serial buyer has saved over three times as much as the 30-year buyer. Granted, they paid an extra $171k in real estate fees and excise taxes to save $110k, but the government-sponsored “savings” provided an immediate gratification.

These numbers are obviously just rough estimates, and don’t take every single variable into account. The purpose is just to point out the approximate magnitude of the current government interventions on the financial bottom line for individuals in the housing market.

With the 30-year buyer in the above scenario receiving roughly $1,700 a year in tax incentives and the 5-year buyer getting $5,300 a year, there is obviously a strong government incentive to not only buy a house, but to become a serial purchaser, swapping houses every few years to maximize the realized “benefits” offered by good old Uncle Sam.

In my opinion, it’s no wonder the housing market has gotten so screwed up when the move most encouraged by the existing government incentive structure is to buy the most expensive house, finance as much as possible, and move to a new, more expensive house as often as possible, basically remaining in a state of permanent home indebtedness.

Thanks to Rhonda Porter for assistance in calculating the costs and rates for FHA financing used in this post.

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About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market. Tim also hosts the weekly improv comedy sci-fi podcast Dispatches from the Multiverse.

37 comments:

  1. 1
    AMS says:

    “1 point paid on FHA 30-year fixed financing for an APR of 5.489%.”

    Wouldn’t 5.5% be close enough? We’re not talking rod bearing clearances here.

    It’s also interesting how the capital gains are handled. “The 5-year serial buyer saved an additional $4,081 in capital gains tax exemption.” This is really a time value of money issue. The 30-year buyer has the same benefit, but it’s unrealized on that same date.

    One more comment: The duration is being extended for the 5-year buyer. Thus the principal balance is not falling as fast. If the interest rate is high, then this is an unfavorable condition. If rates are low, then extending the duration is favorable. There is a value in borrowing cheap money longer.

    If, on the other hand, rates are increasing and the 30-year fixed is locked in at a low rate, then the 5-year swaps get worse and worse. And vice versa during a period of falling rates.

  2. 2
    The Tim says:

    RE: AMS @ 1 – I just used the rate quoted by Rhonda in her most recent rates post on RCG. You’re right of course regarding the capital gains tax, but the whole point is that the current incentive structure provides an economic incentive for people to cycle through the process as often as possible.

    As far as rates go, I did make the assumption that the rates would be constant throughout the 30 year period. Obviously if rates increase, the 5-year serial buyer ends up paying much more in interest. Of course, that just increases their government kickback in the form of savings from income tax deductions, so yet again the incentive seems backward.

  3. 3
    Scotsman says:

    ” the move most encouraged by the existing government incentive structure is to buy the most expensive house, finance as much as possible, and move to a new, more expensive house as often as possible”

    Heh. It’s almost as though the real estate lobby, uh, I mean government, designed it that way…

    But this is just the tip of the iceberg- the local governments, banks, and a host of other entities are also tied into a healthy growth in real estate transactions and values. As I stated in another post, I wouldn’t be surprised if the various levels of government were the largest factor in what happens to home prices.

    One issue we aren’t too aware of here in the NW is how burdensome property taxes can be. In many areas of the Midwest and NE monthly property taxes can be as much or more of a deal breaker than the mortgage on a home purchase decision. The homes may be cheaper, but the taxes are unreal. The one constant is the level of available income- the question is how it gets divided up.

  4. 4
    hinten says:

    Tim,
    next thing you will say is that the federal child tax credit encourages fornication.
    Crazy, I tell you, crazy.

  5. 5

    I’m not understanding the sell/buy every five years scenario. I assume they’re selling at the 3% annualized price, but what are they buying? Another house that same price? Seems like the transaction costs would eat them up unless they were moving up, further leveraging their investment (and maybe even then).

    Maybe I’m missing something, but you’re also not accounting for the tax benefit of paying real estate taxes. You could estimate that at 1% of the value of the house each year.

    Also, it would be nice if you indicated the net equity each party would have at the various points in time. The first one would be about $700,000 at the end of 30 years, but I have no idea what the second one would be, and the renter would be zero.

  6. 6

    RE: hinten @ 4 – It might discourage birth control. People will do irrational things to save a bit of tax. In my business school days one of my professors suggested some doctors would flush a dollar down the toilet to save 40 cents on taxes.

  7. 7

    One other point on this topic. The interest and real estate tax deductions have been around a long time–so long I’m not even sure how long. But my guess would be that at the time each started, people who owned homes tended to live in them a long time and pay them off. Thus the government was encouraging a type of retirement fund. Somewhere in the 70s or 80s that changed as Americans became more mobile. Perhaps where the move wasn’t for a job change, you could argue that the government programs encouraged people to borrow more and more money.

    In that regard, one fairly recent change is that I don’t believe the interest deduction is limited by the basis in the property, but instead by the FMV. During the times values were rising, that encouraged people to transfer other borrowing to become borrowing against their houses. I never understood why that was being encouraged (or why the IRS wouldn’t go nuts over a limitation that couldn’t be precisely calculated).

  8. 8
    David Losh says:

    RE: The Tim @ 2

    You have brought up a good point. The trade up was supposed to build equity. You would buy a place as a starter, work on improving it, sell, and take the equity as a larger down payment on the next property. In the past you had to transfer the equity or pay tax on the money. Now that you can just keep the money tax free the building equity goes out the window.

  9. 9
    The Tim says:

    RE: Kary L. Krismer @ 5 – I intentionally was not addressing the total equity question since that has been addressed many times before here and I was trying to limit the scope of this post.

  10. 10

    RE: David Losh @ 8 – But the old system was a disaster. If you traded up, your basis was still dependent on the prior property, and then if you traded up again it was dependent on all three properties, etc. It was an accounting nightmare. That’s like one of the reasons I told my wife we were going to sell our old house. Not having to worry about basis was important when she’d bought the house so long ago and then we’d spent money remodeling, and that was only on one house. Imagine having to do 30 years of houses!

    And beyond that disaster, you could have tax disasters too. Because the basis didn’t account for the last property’s gain, a lot of people had debt in excess of basis. That meant they when they did sell in a taxed transaction they’d likely have more tax liability than funds from the sale, especially if that taxable transaction was a foreclosure. I had a client once how had that happen and owed about $40,000 in taxes. The foreclosure sale happened about 90 days before the change in the law, and he didn’t know about it and didn’t come to see me before hand. There were a lot of people in that situation before.

    Oh, and I think you’re wrong as to the prior law. I think you could pull money out. It was the purchase price that the IRS paid attention to.

  11. 11

    RE: The Tim @ 9 – How about explaining the second scenario. What is the purchase transaction at the end of the first five years going to look like?

  12. 12
    AMS says:

    RE: The Tim @ 2 – Oh, and you made the necessary assumption that the tax laws don’t change. If you relax that assumption, this would quickly get complicated, Monte Carlo Style, maybe.

    There is another critical assumption here: There is no tax benefit to renting. As I have discussed in the past, the tax benefits of renting are much better, but they are realized in the form of reduced rent. This makes the specific benefit difficult to quantify.

    It might be interesting to take two individuals who buy nearly identical properties for the same price at the same time. It could happen with certain developments. Run the total tax savings based on each one taking an owner-occupied position. Then compute the total tax savings if each one were a landlord to the other. First assume equal tax brackets, but then assume that one is in a higher tax bracket, as many landlords are. I hope it is clear that the tax benefits are much greater for the rental case, yet the two properties are identical.

    As far as the interest rate, I appreciate your asking for a current rate. The problem is that there is more than 11 thousandths worth of error. While not as precise, it would be just as accurate to use 5.5%. Well, hopefully I can make that claim without too much support. Certainly there is a great deal of assumption risk here, and increasing the interest rate by 11 thousandths wouldn’t change the tax benefit much, as it would not increase the total interest paid much. Given the $400,000 home value, .011% = $44, which is below the tax table increments.

    Also you are not clear in how you handle the standard deduction, which all renters do get. While this is not necessarily a tax benefit to renting, it’s given up by those who deduct mortgage interest. If a person pays in cash, then such person maintains the standard deduction. The capital gains tax applies to both those who pay cash and those who borrow.

  13. 13
    AMS says:

    RE: The Tim @ 9 – That Eleua entry is from March 2007. The resistance to renting has not changed much, but those who have been burned by the fire have other ideas. As more and more people get burned, fire safety becomes a bigger issue.

  14. 14
    The Tim says:

    RE: Kary L. Krismer @ 11 – Quoting from the post: “sell house and move to roughly equivalent house.” i.e. – if at year 5 the home they are moving out of is valued at $460,000, they’re moving to another home worth roughly $460,000. If at year 10 the home they move out of is valued at $535,000, they buy another house for $535,000. Maybe they got a different job and are moving closer, maybe they’re moving to another part of the country. Whatever, I don’t care. I don’t know why someone might do that, but I was trying to keep things roughly comparable for this hypothetical scenario.

    Of course if they “traded up,” then the government kickbacks become even more lopsided.

    RE: AMS @ 12 – Yes, you are correct. I tried to simplify the assumptions to keep the comparison from getting too crazy. And again, as far as the precision of the interest rate goes, yes, 5.5% would have been fine, I just copy-pasted from Rhonda’s rate quote into my spreadsheet, and stated what I used in the post.

    Oh, and I used the same method I have described in previous posts for calculating the benefit from the income tax deduction. The benefit for the buyer is calculated as only whatever excess deduction they have vs. the standard deduction. That’s why I clarified in my assumptions that I was basing this on a married couple, since that changes the standard deduction.

  15. 15
    AMS says:

    RE: David Losh @ 8 – One of the things that One Eyed Man has claimed, and I have not disagreed, is that housing price appreciation approximates inflation over long periods of time. I believe that we generally agree that it’s a bumpy ride, and the gaps between the two expand and contract, both favorably and unfavorably.

    If we hold this to be true, then the capital gains tax on primary residence sales was a tax rooted in inflation. In other words, if you bought a $100,000 place for cash and inflation drove the price to $200,000, then if you walk away with $200,000, you are net even with inflation. Taxing the $100,000 at 25,000, plus or minus, depending on your individual tax was an inflation tax.

    Then there was the one time exemption which had a minimum age. It was so long ago I might not be remembering the right age, but 55 comes to mind; the exact age doesn’t really matter. There were people short of the age sitting around just waiting to avoid all that tax. I had a friend who waited just under 5 years. He had a tax basis of $0. He waited, and waited. He put his life on hold so he could avoid the taxes. He had a heart attack during the first few days the house was on the market and died.

  16. 16
    AMS says:

    RE: The Tim @ 14 – I assume you maintained the principal balance on the loan, but extended the duration. Thus principal balance will continue to go down, but at a slower rate with each new home, as the duration is extended.

    There is that 3.5% down but then there’s transactional costs too. Given your assumptions, it appears the owner is taking cash out with each deal, so maybe the principal balance is increasing.

    Also the new homes were not because of a job transfer where further tax benefits might apply.

  17. 17

    RE: The Tim @ 14 – That’s what I didn’t understand. Most people don’t just move to a house that’s about the same price. Why not just have them refinance for the higher amount? That would be something a lot of people did, and some more frequently than every five years.

    The transaction costs would be a lot less that way too.

  18. 18

    RE: AMS @ 15 – I think it was 55, and I think it was a one time thing, such that if you didn’t use up all $250,000, you couldn’t claim the rest later. And yes, the tax on houses was basically an inflation tax for most people. There are exceptions, however.

    As to your friend, sorry to hear that. It’s crazy to me how the tax laws can dominate someone’s life, and things that make that unnecessary (like the current law on house gain) are good things. The other one that’s really bad is the estate tax. I call the the full employment of tax attorneys and accountants tax.

    BTW, merging the two topics, assuming your friend was married his wife would have obtained a step up in basis, and she could have then sold the house tax free.

  19. 19
    AMS says:

    RE: Kary L. Krismer @ 18 – The wife died 7 days prior.

  20. 20
    kurt says:

    The (fractional reserve banking based) economy depends on people taking on debt in order for money to be created. You can see how these policies allow more people to get mortgages so banks can ‘print’ more money (and reap the benefits of interest). The government is subsidizing the banking industry and making it more ‘attractive’ to take on serial mortgages.

    Great data. I just love this blog.

  21. 21
    David Losh says:

    RE: kurt @ 20

    I agree and don’t have my mind completely around the printing of money concept by banks creating interest payments. I can see the broader economy based on credit and debt, but this thing about mortgages still eludes me. Better yet, I have been in the mortgage mill for so long that it seems normal to me. It wasn’t that long ago that I just wanted to get to cash.

  22. 22
    2kt says:

    The true nature behind these subsidies to buy/own real estate is a creation of tax base for local governments.

    If you want to look at a true picture, why don’t you run 30-year property tax cost projection alongside. Then all your numbers will look much more different.

  23. 23

    Although the buyer credits are new, mortgage interest deductions are pretty sacrosanct, a long standing tradition that’s not about to go away. Sure, it’s a giveaway to the real estate industry, but it’s as much an American tradition as apple pie. See how far you get proposing to your elected representative that they do away with it.

  24. 24

    RE: The Tim @ 2 – The actual rate that was quoted for that APR is 4.875% — I never encourage people to view rates by APR as the calculations can be flawed–The Tim not rounding the APR to 5.5% is correct. Part of the reason the APR is a bit higher than the Note rate with FHA is that the mortgage insurance (monthly and upfront) is factored into the APR calculations.

    One of the few positives with the new GFE is that it will make it easier to compare.

  25. 25

    RE: Kary L. Krismer @ 18 – I had a hard time picturing seeing people move into the same home with the 5year mover too, Kary… I’m thinking that it could make sense if you consider some of the most common reasons people move–“move up”, divorce (could be the same size or smaller home) and down sizing.

  26. 26
    Tim says:

    Tim- I immediately thought of a new car bumper sticker: Visualize Gov’t Housing Kickbacks (vs. Visualize Ballard) LOL.

  27. 27
    Scotsman says:

    Why a 35% Decline in Housing Values Would Be Good for the Nation

    http://www.oftwominds.com/blogdec09/housing-decline-good12-09.html

  28. 28

    RE: Ira Sacharoff @ 23 – I’m happy to have what tax deductions we have, Ira. We all ready are so taxed and residents in WA will be facing even higher taxes.

    I have to credit NAR for keeping that tax deduction around…no elected official is going to stand up to their lobbyist.

  29. 29
    David Losh says:

    These kick backs are, or were, the biggest tax breaks Americans had. Now we have the Roth/IRA diversions.

    When you work a job you get nothing. Home ownership for most people will be the biggest investment they ever make. You pay lip service to a forced savings plan, but the reality is you can buy, and pay off pretty quickly if you do it well.

    The home you buy is a business decision. You buy what you can afford to pay off, or pay down, to build equity. That’s how it works.

    I’ve been listening to talk radio this week to be more able to relate to some of the ideas on this blog. It’s just scary that people buy into this stock market BS. Your Roth/IRA will never add up to a hill of beans. For all the talk about the stock market it all comes down to institutional trading. Without insider information the working people never stand a chance.

    You home is what will carry you through if you do it correctly. Most people have gotten caught up in the same hype that some how a Real Estate is tied to the stock market, or traded like stocks. It’s not.

    You make the best deal you can, pay it off, build equity, trade up, down or sideways, if you need to, and go onto the next one, or not. The government kick backs are a very, small, tiny, tool for you to use, and cost the tax payers nothing. If dollars weren’t in the home ownership, they would be in Afghanistan.

  30. 30
    David Losh says:

    RE: Rhonda Porter @ 28

    I would think the Mortgage Bankers Association benefits far more than the National Association of Realtors from the interst tax deduction.

  31. 31

    RE: David Losh @ 30 – That would be debatable, but I don’t think you would have seen as much of the pattern of converting credit card debt into house debt without the deduction.

    I would prefer an interest deduction that limited interest to the interest paid on the price paid for the house when you bought it, like I think was the case 20 years ago.

  32. 32

    You Need To Add To All the Red Bars

    The extra income tax increases we’ll soon all be paying for welfare to the upper middle class.

    Ohhhhh….that’s right, we’ll just tax the super rich for the welfare credits, then decrease all the red bars with deflation as the companies lay more of us off.

  33. 33
    sullim4 says:

    One big thing I see missing here is that there’s no mention of the 6% that the seller’s agent typically gets. That substantially adds to the cost for the serial home purchaser.

  34. 34

    RE: sullim4 @ 33

    Good Point

    Millionaires are notorious for keeping their perfectly good old cars and homes, everytime they buy something else new they lose more money…..how do you think they got to be millionaires?

  35. 35
    The Tim says:

    RE: sullim4 @ 33 – Agent costs per sale are factored in. That’s the main reason why the 5-year buyer’s cumulative costs are noticeably higher than the 30-year buyer.

  36. 36

    Tax Credits to Home Buyers a Failure

    Article in part:

    “….The National Association of Home Builders said Tuesday its housing market index fell by one point to 16 this month, reflecting concern that job losses and a slow economic recovery will continue to stifle demand for new homes despite the extension of a federal tax credit for buyers….”

    http://finance.yahoo.com/news/Homebuilder-sentiment-index-apf-287163691.html?x=0&sec=topStories&pos=main&asset=&ccode=

  37. 37

    RE: David Losh @ 30 – I believe NAR has far more lobby power than the MBA or NAMB.

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