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Post 20

Wednesday, September 10, 2008 - 5:13pmSanction this postReply
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Steve introduces another topic, property taxes, which the writer on Justice for Renters doesn't mention. Property owners get a tax deduction for those, too, and a renter does not.

Giving it more thought, I'm less sympathetic now. That the property owner gets a tax deduction for mortgage interest and property taxes is most likely taken into account when the property owner (landlord) decides what amount of rent is needed to make a target level of profit. Thus the renter gets an indirect break for the mortgage interest and property taxes the property owner pays.




Post 21

Thursday, September 11, 2008 - 4:45amSanction this postReply
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Fannie Sells $7 Billion in Notes
 
Bailout for Billionaires

(Edited by Merlin Jetton on 9/11, 5:01am)




Post 22

Thursday, September 11, 2008 - 9:05amSanction this postReply
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Merlin, let me see if I understand you and the blogís author.

 

As I understand it, rents on commercial real estate are taxed net of expenses, i.e. there is a tax on profits. The mortgage interest is passed-on to the renter as a cost that has to be exceeded before there is a profit. It is a deduction on the landlords balance sheet because the landlord only pays taxes on profits.

 

If the mortgage interest is $1000/mo and the rent is $1200/mo the landlord pays tax on $200 (letís say $40). The renter pays tax on the $1200 of his personal income used to pay the rent without the opportunity for a deduction. Consequently, taxes are paid on each transaction (salary and rent). The renter misses the tax benefit (letís say it is $400) and pays the taxes on the $200 of the landlordís profit and that is built into the rent (the $40).

 

If a homeowner pays $1000/mo in interest they can reduce their taxes on their salary (a $400 savaings). Since they are both owner and housing consumer there is no second transaction that is taxed and the extra $40 doesnít accrue to the government.

 

Am I missing something? It seems that the government gets an extra $400 from the renters out of their salary plus another $40 from the renter that is collected by the landlord. It seems worse when considering the landlord's taxes. Of course, not all things are held equal and I may be missing something.

 

 




Post 23

Thursday, September 11, 2008 - 10:34amSanction this postReply
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Jason,
There would be other expenses the landlord/owner would consider like property taxes, principal part of mortgage payment, depreciation and expenses, but I will ignore them for simplicity and work from your numbers as much as possible, including the 40% tax rate.

Like you say, the landlord's pre-tax profit is: $1200 - $1000 = $200. The after-tax profit is: $200 * (1-.4) = $120. 

Let's assume $120 meets the landlord's target after-tax profit.

What I meant was that if the landlord did not get to deduct the $1000, then he would have to charge a higher rent to end up with the same $120 after-tax profit. How much? X*(1-0.4) -$1000 = $120. Solving, X = $1867, a lot more.

If a homeowner makes mortgage payments of $1200 with $1000 of it interest, then yes, the renter appears to be disadvantaged. However, it doesn't consider that the renter would pay $1867 if his landlord didn't get the tax deduction. On the other hand, the renter is at a disadvantage in that he is building no equity.

Yes, the government is getting $400 more from the renter by not allowing a deduction, but it's getting $400 less by allowing the landlord's deduction.

(Edited by Merlin Jetton on 9/11, 10:37am)




Post 24

Thursday, September 11, 2008 - 11:45amSanction this postReply
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"Yes, the government is getting $400 more from the renter by not allowing a deduction, but it's getting $400 less by allowing the landlord's deduction."

 

I donít follow that last claim. The government is getting $400 less? How? The government collects $400 from the renter and perhaps a few dollars from the landlord due to the fact that his profit is taxed. It gets neither of these amounts if the property is owner-occupied. Net, the government gets $400+ more if the property is rented than if it is owner-occupied.

 

We can make the example extremely simple by considering a condo that is owner-occupied and one that is rented. Everything is the same except the renter pays a little more (if the owner makes a profit) and heís out $400 to the government. If there is no profit, the renter has to cover the same costs (interest, prop taxes, maintenance, etc.) as an owner who occupies his condo. The renter does it without the ability to use his full salary as he isnít allowed to keep as much.

 

What am I missing?




Post 25

Thursday, September 11, 2008 - 12:32pmSanction this postReply
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Me: "Yes, the government is getting $400 more from the renter by not allowing a deduction, but it's getting $400 less by allowing the landlord's deduction."

Jason: I donít follow that last claim. The government is getting $400 less? How?

I was comparing taxable income for the landlord of $1200 - $1000 (gets deduction) versus taxable income of $1200 (no deduction).    0.4 * ($1200 - $1000 - $1200) = -$400.

(Edited by Merlin Jetton on 9/11, 12:55pm)




Post 26

Thursday, September 11, 2008 - 1:06pmSanction this postReply
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Merlin, the problem with your logic is that you are looking at a second taxable transaction that only exists in the renterís case.

 

In the home owners case there is one taxable transaction: the personal salary from one's job.

 

In the renters case there are two taxable transactions: the personal salary of the renter and the profit of the capitalist/landlord from renting.

 

Youíre noting that the landlord isnít being taxed for interest because it is a cost. Quite correct! If he was taxed on gross profit (rent Ė cash costs) and not net profit (rent Ė cash costs Ė interest costs) he would be paying higher taxes.

 

However, for the owner-occupied cases there is no second transaction and thus no taxes at all!

 

The renter situation has double taxation by the very fact that there are two transations. There are taxes at salary time for the renter and taxes at income time for the owner. If there were no deduction for costs for the landlord the government would get $400 from the renter and another $400 from the landlord. Double taxation! In the owner's case the government gets neither.

 

In the end the bottom line is that the government gets $400 more when the property is owned by a capitalist and rented (assume no profit for now) then when it is owner-occupied by a person who gets an interest-rate deduction. That $400 is money the government gets at someone elseís expense: the renter.  

 

 




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Post 27

Thursday, September 11, 2008 - 2:12pmSanction this postReply
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Strictly speaking, transaction taxes are not at the expense of the buyer or the seller, but at the expense of the market. When you have to raise the rent to cover a tax you diminish the desirability to renters and have greater vacancies to absorb. If you can't raise the rental rate enough because of the already high vacancy rates (competition) then you have to accept a lower rate of return (lots of properties are currently rented out at negative return rates). If raising the rate has no effect on your ability to rent, then you were giving away money you could have had before and just didn't know it.



Post 28

Thursday, September 11, 2008 - 2:45pmSanction this postReply
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Jason, I'm not sure I get what you are saying, but it seems to be like the following.

Owner-resident:  $3000 income, $1200 mortgage payment, $1000 interest
   tax = .4*($3000 - $1000) = $800
Renter-resident:  $3000 income, $1200 rent
   tax = .4*($3000 - $0) = $1200

Just comparing these two calculations, I don't disagree that the government gets $400 more in taxes in the renter case.

On the other hand, the renter-occupied case requires a landlord -- whom I say should not be ignored -- and the owner-occupied case does not. When the landlord is recognized, the government is getting $400 less, since the landlord gets a tax deduction for interest, resulting in a tax of $800 in both cases.

The favoritism of owner-resident could be removed by ceasing the owner-resident's interest deduction. But that is not what the author of Justice for Renters advocates, to wit: "Renters should be given an equivalent deduction to match the average interest deduction of the home owner." The implication of that advocacy is, like I said earlier, a double deduction that the IRS will be against.

Your bottom line is that the government gets $400 more in the renter-resident case (ignoring the landlord) than the owner-resident case. Another way of saying the equivalent thing is that the government gets $400 less in the owner-resident case. I prefer to say it that way, and it's the result of allowing the owner-resident a tax deduction.




Post 29

Thursday, September 11, 2008 - 7:22pmSanction this postReply
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Iím glad we agree that the government gets $400 more in the renterís case. And from your calculation above the owner has $400 more of disposable income. Correct?

 

Now you say: The favoritism of owner-resident could be removed by ceasing the owner-resident's interest deduction.

 

Yes, of course. But the fellow on the website clearly respects the rights of the owner to keep his income. Heís just asking for parity for renters: the right to keep the same amount of disposable income. I gather you would rather raise the rates on the owner-occupied individual while the website in question and I in particular would rather lower the taxes on the renter.

 

Do we understand each other now?




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Post 30

Friday, September 12, 2008 - 2:47amSanction this postReply
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Jason Pappas wrote:
Iím glad we agree that the government gets $400 more in the renterís case.
Yes, ignoring the landlord.
And from your calculation above the owner has $400 more of disposable income. Correct?
Yes.
But the fellow on the website clearly respects the rights of the owner to keep his income. Heís just asking for parity for renters: the right to keep the same amount of disposable income. I gather you would rather raise the rates on the owner-occupied individual while the website in question and I in particular would rather lower the taxes on the renter.
TskĖtsk and no. I'd rather cease the deduction for the owner-resident and lower tax rates for all. The net change for owner-residents could be about nil, and renters could gain. That's parity, too.
Do we understand each other now?
I hope so. :-)




Post 31

Friday, September 12, 2008 - 3:26amSanction this postReply
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TskĖtsk and no. I'd rather cease the deduction for the owner-resident and lower tax rates for all. The net change for owner-residents could be about nil, and renters could gain. That's parity, too.
That just another way to say the same thing. We've argued for a half dozen posts because you'd rather give both a lower tax rate in two steps (and a simpler end result) while we'd do it in one. You'd have a lower rate so that the owner-resident would get to keep his income without the need of a deduction and we'd give the owner-renter (and anyone who doesn't have an interest-rate deduction) and equivalent deduction.

Are we not saying the same thing but packaging it differently?





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Post 32

Friday, September 12, 2008 - 4:11amSanction this postReply
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Are we not saying the same thing but packaging it differently?
We are saying a similar thing.  However, let's consider the bigger picture. Over the years the tax system has become more and more complex, with special interests pleading for a change in the rules to benefit them and succeeding. Medical expenses, education expenses, special treatment for hedge fund operators (a boon to John Edwards, by the way), and so forth. A tax deduction for renters is more of that. It's difficult to say how much, but don't you think the deductibility of mortgage interest for owner-residents added to the severity of the current crisis? It seems to me so, especially for owner-resident "flippers". They buy and move into a property, live there for a little while, deduct the mortgage interest, and wait for the market value of the property to rise enough for a tidy profit. Then they repeat the cycle.

Mortgage Lending Fell Sharply Last Year

Wait a while to see the numbers for this year. Wait a while longer for politicians and some activists to use the numbers to accuse lenders of racism and/or "skimming the cream."




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Post 33

Friday, September 12, 2008 - 5:39amSanction this postReply
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We are saying a similar thing.  However, let's consider the bigger picture. Over the years the tax system has become more and more complex, with special interests pleading for a change in the rules to benefit them and succeeding.

 

We can move on to this point but first do we agree that the renter is out what the owner-resident is allowed to retain: the disposable income from the interest-rate deduction ($400 in our example)?

 

Let me assume you now agree with this. If so the question remains which way to achieve parity. You point out that deductions are problematic because they give Ďspecial treatmentí to some. That's certainly true. Others are left holding the bag.

 

The idea of focusing on deductions to renters (and all other who donít have an interest-rate deduction) is a way of respecting the rights of home owners to keep their hard-earned salary (to pay for their American Dream) while demanding respect for all others to keep their hard-earned income, too. I donít want to hurt home-owners and you donít either (youíd compensate the loss of deduction with a general tax decrease).

 

In other words, what we are saying is that everyone gets an interest-rate deduction even if you donít have a loan. Iíd allow that to expand so that even those that donít itemize get that deduction (increase the standard deduction to a flat amount plus a percentage). This will eventually make deductions irrelevant by giving them to everyone.

 

This is just a simple way of saying letís help everyone get a lower tax by bringing down taxes for those who donít have the aid of a deduction. Politically it is difficult to oppose deductions because people wonít believe ďbut youíll still pay less when we lower the rates.Ē I donít blame them. Rates can go back up and youíll be without the aid of a deduction. (I give Peter Schwartz credit for this point circa 1980s.)

 

People donít trust the government. Iíd focus on the injustice and those who are unfairly paying the tax burden. Itís a way of raising peopleís awareness of the unfairness while not attacking those who already have a chance to keep their income. I donít want to pit owner-resident against renter. I want to welcome the renters (and others) on board the freedom train by allowing them to keep more of their hard-earned income. I focus on those who benefit. I agree with that blogger. Letís focus on the positive.







Post 34

Friday, September 12, 2008 - 6:53amSanction this postReply
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We can move on to this point but first do we agree that the renter is out what the owner-resident is allowed to retain: the disposable income from the interest-rate deduction ($400 in our example)?

Yes. I already agreed -- posts 28 and 30.
Politically it is difficult to oppose deductions because people wonít believe ďbut youíll still pay less when we lower the rates.Ē I donít blame them. Rates can go back up and youíll be without the aid of a deduction. (I give Peter Schwartz credit for this point circa 1980s.)
That's a very good point. I recognized it earlier, but didn't say so. I gave you a token anyway.
I agree with that blogger. Letís focus on the positive.
He has my empathy. However, a lower tax rate is a positive, too, and ceasing the mortgage interest deduction removes his main cause to complain.

(Edited by Merlin Jetton on 9/12, 7:06am)




Post 35

Friday, September 12, 2008 - 7:14amSanction this postReply
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I think we mainly agree but differ on the best way to get there. Thereís much to say about the prospects of differing approach. I certainly welcome and applaud all efforts to reduce taxes. I donít disparage any road forward.




Post 36

Friday, September 12, 2008 - 1:40pmSanction this postReply
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You guys both want lower taxes and much of the disagreement seems to be more in accounting than political principles and certainly not in ethics.

What about my suggestion that local taxes be reconfigured. Create a county-wide proposal that real property no longer be taxed at all. Instead two new tax regulations replace the real property tax in the county and that it start at the same revenue level. The first tax would be for schools. Each household to be taxed for each student that attends a public school - not really even a tax but rather a tuition - which is what we do for colleges and universities. And it makes more sense to not bill people, but just collect it at the school each quarter. The other tax could be called the safety services tax. It would be for the remainder of the required funds and intended to cover admin costs, court costs, police, fire, emergency rooms, etc.

The advantages are obvious. People with kids pay for their education and people without kids don't carry someone else's burden. And this would focus parents and empower them to have more control over the K-12 system. It completely skips the whole voucher system - which can easily turn into a mess and has never gained traction. Seeing the itemized costs for the admin and safety functions would also focus people to demand specific changes in those services.

The federal and state tax returns for counties with this system would still let people take deductions for local taxes and for interest on mortgages, but there would be no property tax to expense on a landlord's P and L statement.





Post 37

Friday, September 12, 2008 - 2:18pmSanction this postReply
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Steve wrote:
The federal and state tax returns for counties with this system would still let people take deductions for local taxes and for interest on mortgages, but there would be no property tax to expense on a landlord's P and L statement.
Why wouldn't there be an expense on a landlord's P and L for admin costs, court costs, police, and fire? I'm inclined to allow an owner-resident a tax deduction for these things because they are, practically speaking, a tax. That is not so for mortgage interest.

I generally agree with your two middle paragraphs.





Post 38

Friday, September 12, 2008 - 2:22pmSanction this postReply
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Hey, given that the tax code isn't really based upon logic anyway, whether it makes sense to provide that deduction or not doesn't matter. I agree that they could make it deductible, partly because it makes sense, and mostly just because less taxes are better taxes.



Post 39

Sunday, September 14, 2008 - 9:14amSanction this postReply
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This is an elaboration on post 1. 

Like I said there the carving and repackaging of pools of mortgages became more and more complex over time. Tranches became smaller and even default risk was moved around. This made it ever harder to place a "fair value" on a particular tranche. To use a computer model to calculate a fair value requires modeling every tranche in the pool that will be paid before or concurrent with the tranche for which you seek the fair value. The model requires making assumptions about prepayment rates, default rates, and recovery rates (when a default occurs and which in turn depends on housing prices). The values become more iffy, especially for the more "downstream" tranches.

A potential buyer of a tranche is inclined to make assumptions that result in a lower "fair value". When the market doesn't have many trades to test the assumptions, that adds to the iffyness. The iffyness is why it is so hard to gauge the overall depth of the current mortgage crisis, and even a "fair value" of assets of a big holder like Lehman Brothers (and Bear Stearns earlier). As said earlier these CMOs are widely held.




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