The ways in which a tax change can affect the homebuilders

Market Realist

Why a little-known tax change may be a big deal in the real estate (Part 1 of 5)

Short sales have been a way for underwater homeowners to get out from under their debt

A short sale happens when a homeowner sells their house for less than the remaining principal on the mortgage. Short sales are difficult to execute typically because there are invariably second liens on the property (usually home equity lines of credit), and both creditors have to sign off on the deal. Usually the first lienholder tries to get the second lienholder to take pennies on the dollar, and the second lienholder refuses. Both parties have to take a haircut and work it out between themselves. That is why short sales take a long, long time to close (usually 6 months to a year, depending on the state). That said, they are an effective way for a borrower who bought too much house to simply walk away and find a more affordable place to live.

A temporary tax break expired at the beginning of the year

Just as the real estate market was rolling over in 2007, Congress passed the Mortgage Debt Forgiveness Relief Act (aka MDFRA) of 2007, which forgave taxes owed when a principal modification happens to a mortgage. If you owe $300,000 on your house and are having trouble making your payments, the lender may forgive some of that principal in order to lower your payment. The problem is that forgiveness is now considered taxable income, and the taxman is going to take a share of that, which means a big tax bill.

Congress is considering ways to extend the break

Congress is trying to figure out a way to extend the tax break retroactively. There are bills to extend it through 2016, and it has the support of many state attorney generals, along with the usual consumer advocate/fair–lending types. However, passing anything in this polarized Congress is a difficult thing.

Implications for homebuilders

Homebuilders like Lennar (LEN), Toll Brothers (TOL), D.R. Horton (DHI), and PulteGroup (PHM) compete with existing homes for potential customers. Removing inventory will mean more demand for newer homes, and higher average selling prices. Investors who are interested in trading the homebuilding sector as a whole should look at the S&P SPDR Homebuilder ETF (XHB).

Continue to Part 2

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