A Call To End Tax Free Gains On Real Estate

I came across an article on msn.com this morning by a Business Week writer who is complaining about the $250,000 to $500,000 tax free gains policy the IRS provides when selling a residence. (If you aren't aware, you can sell you house and keep up to $250,000 of gains tax free if you are single, or up to $500,000 of gains if you are married. You must have lived in the property for 2 of the last 5 years to qualify for this.) Basically, he is saying this skews investments away from businesses and into real estate and encourages people to move every 2 years. His complaint is that other investments, such as stocks, are subject to a 15% capital gains tax and he doesn't see why selling a home should be any different. The article sounds like sour grapes from a stock investor.

The author states "The powerful lure of tax-free profit is one reason that home prices have risen at a nearly 7% annual rate, vs. about 4% for the stock market since 1997." Although he mentions it briefly, he dismisses all-time low interest rates as a major factor (perhaps the major factor) in the real estate boom and instead seems to think everyone is buying a new home every 2 years solely for the tax benefit. He also misses the boat in assuming it is owner-occupants (the only ones eligible for this tax break) who are driving up the housing market. What I believe is really happening is investors are buying houses for rentals, not to live in. Turning a profit on these investments is pretty easy, given low interest rates. That is what is inflating the price of a house.

Had he really understood real estate investing, rather than railing against the tax break on the sale of a primary residence, he would instead be railing against the tax advantages of the 1031 exchange, which allows investors to defer capital gains tax on income property indefinitely.

Finally, he states "As much as possible, the tax code shouldn't bias investment decisions." On the contrary, the tax code is expressly designed to bias investments toward what the government believes people should be investing in. Take, for example, all the tax benefits of owning a small business. The government wants businesses created so that more jobs can be made, jobs from which the government collects payroll taxes. The tax code encourages investment in real estate so that a healthy housing market is maintained and the government does not have to provide shelter for millions of people.