If you are considering selling your home, you might want to pull the trigger before the end of 2008. The federal government determined that millions in taxes were being drained off each year because of the way investment property sales have been treated for tax purposes. On January 1, 2009, a provision in the housing bill HR 3221 plugs that hole and it’s investors who may end up high and dry.

Homeowners were happy to recycle–their exemptions, that is. Before HR 3221, people were allowed exemption from taxation on the first $500,000 of their home selling profits if they were married filing jointly or $250,000 if  filing singly. The only restriction was that they had to have lived in their homes for two out of the most recent five years. Vacation homes or investment properties that were converted to primary residences qualified for this treatment as well. This allowed property owners to sell their residences, exclude the capital gains, move into vacation or rental properties for a couple of years, and then sell them and exclude the gains again. Who needed to work for a living?

Turn out the lights….the party’s over. While it took some time, the government did finally catch on. HR 3221 contains a provision for calculating the gain on the sale based on how many years the taxpayer lived in the property versus how many years it was owned starting 1/1/09. Merely moving in for two years will no longer allow you to take advantage of the full exclusion available. To determine how much gain will be taxed, perform this calculation. Take the number of years the house was not used as a primary residence and divide by the total period of time the home has been owned starting January 1, 2009. Multiply that result by the gain on the sale of the home to get the taxable gain.

For example: A single taxpayer has owned a vacation home since 2000. In 2006, he moved in and lived there for 2 years, selling the property in 2008 and making a profit of $300,000 on the sale. He gets to exclude $250,000 from capital gains tax because he sold in 2008. But under the new rule (and this may eventually be interpreted differently, the IRS has yet to issue guidelines), the capital gain that can be excluded will be determined by the number of years the property functioned as a primary residence divided by the number of years the property was owned. If you own property, the ownership clock restarts 1/1/09. All currently-owned property will be treated for  tax purposes as though it was purchased on that date. So if you have lived in your former second home at least 2 years and are thinking of selling, you might want to either unload it now (to take advantage of the old guidelines) or move in and plan on staying at least two years. That way when the clock restarts it’s already your primary residence.

Otherwise, you will want to live in the property as long as you can before selling. For example, if you keep the property for 3 years, then move in for 2 years before selling, you get to exclude 40% of the capital gain and will have to pay taxes on 60% of it (because you lived in the home for 2 of the 5 years you owned it starting 1/1/09). The longer you live in the property before selling, the higher the portion of gain you’ll be able to exclude.

This is new law, and the IRS has yet to issue guidelines. Be wise and seek professional advice from a tax accountant or property lawyer when you are considering buying or selling your home so that you can determine the financial repercussions. However, with this new law coming into effect on January 1, now might be the time to pick up the phone.

The past week saw more symptoms that the mortgage crisis is likely to drag on: 

• Stocks in mortgage financers Fannie Mae and Freddie Mac took a tumble, as investors questioned their long-term viability
• The problems of Fannie Mae and Freddie Mac are already evident to mortgage borrowers in the form of higher fees, tougher approval standards, and higher interest rates
• Mortgage experts warned that the impact of so-called “liar loans” has yet to fully play out
• Not surprisingly, with these and other woes, mortgage application volume continued to slip

For prospective homebuyers, these symptoms of long-term consequences of the mortgage crisis signal that waiting for the storm to blow over may not be the best strategy.

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News trickling out of regulatory offices and lending institutions indicates that the much-touted HUD foreclosure prevention program set to begin in October has hit a few snags. According to American Banker, it is likely that regulatory agencies will not be prepared to begin handling the cases by October 1. In addition, it is expected that this program will meet with the same very limited success that FHASecure did, and for the same reasons.

The biggest obstacle is that loan servicers–those who buy the loan from the original lender and then collect the payments–are the ones foreclosing and are not in a position to originate a new loan as required  by the program. And of those who are licensed and staffed and capable of originating loans, many do not have FHA licenses which are required by law in order to originate an FHA mortgage.

So if you are counting on a rescue to get you out of a home foreclosure in october, don’t. the only thing you can count on most likely is more red tape.

Analysis by Lizzie O’Leary of Bloomberg News:

Mortgage rates remained unchanged for the second consecutive week, as a troublesome reading on consumer prices neutralized growing optimism over falling oil prices.

Though the Consumer Price Index (CPI) measures a period which trails the recent declines in oil prices, the latest reading was a reminder of how difficult it can be to put inflation back in the bottle once it escapes. 

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Most tax breaks for homeowners are worthless to those who don’t itemize deductions on a Schedule A. Which is about 63% of Americans! The tax benefits of home ownership go mostly to the affluent, who generally have mortgage interest and other deductible expenses that exceed the standard deduction of $5,450 for singles, $10,900 for married couples, and $8,000 for heads of households.

So those with lower income may derive less financial benefit from homeownership. However, the new housing reform law did throw in a benefit to those who take the standard deduction. Even taxpayers who take standard deductions will be able to subtract property taxes from their taxable income (up to $1000 for married couples and $500 for others). Add this credit to the $7500 first time homebuyer tax credit and you get at least 8000 reasons to buy this year if you can swing it.

For the less affluent, the fact that the $7500 is a refundable credit is critical. The credit isn’t even available for single taxpayers whose AGI exceeds $95,000 and married couples with an AGI over $170,000. But even people who pay little or no tax benefit from this credit. For example, Joe Paycheck has $2,500 in federal taxes withheld from his salary during 2008. His tax bill for the year is $3,000. Normally, Joe would have to cut the IRS a check for $500 on April 15th. But in 2008 Joe became a first time home buyer. So he’s eligible for a $7,500 tax credit. Instead of paying the IRS $500, Joe gets a check for $7,000 (the $7,500 credit minus the $500 owed). Not bad.

There is a little catch. The credit gets repaid to the IRS over time ($500 per year for 15 years). If the home is sold before then, the unpaid credit would be repaid from the profit of the home sale. If there isn’t enough profit from the home sale, the credit is written off and the IRS doesn’t get repaid. So a first-timer could buy a house, live in it for a couple of years and sell it, and even if there was no profit on the deal the seller would be $6,500 ahead (the $7500 credit less the $1,000 repaid over two years). So there is a sizable upside to the process. If considering a first time home purchase, check with a tax pro for the whole scoop on the new tax credits. Then check with a lender to see if you can afford to become a first time home buyer.

Current events give a good demonstration of what really drives market interest rates:

• The Federal Reserve decided to leave short-term rates unchanged, at 2.0%
• And yet, thirty-year mortgage rates have eased off their recent highs over the past two weeks

The reason for the drop in mortgage rates can be traced to a third significant development:

• The price of oil slid to around the $120 a barrel mark, some 18% below its peak of $147

All of which suggests that potential homebuyers — or mortgage refinancers — would do well to keep their eyes on the price of oil in the weeks ahead. 

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Mortgage news was dominated by two items this week:

• President George W. Bush signed the mortgage relief bill, designed to help troubled home owners stave off foreclosure
• A prominent home price index reported a 15.8% decline for the year ending May 31, 2008, the biggest year-over-year decline so far

On the surface, the first would seem to be a highlight, and the second a lowlight, of the week’s mortgage and housing news. Reading between the lines, though, reveals that the first item may not be as good as it’s been reported, but the second item may not be as bad.

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For once, “It’s a Great Time to Buy!” isn’t just a bunch of real estate industry hype. Remember, these people were crowing, “It’s a great time to buy!” right up to the moment the housing market crashed and proved that salespeople are not the best industry forecasters, duh. But current economic and market conditions are in fact creating an environment for buyers that may be extremely favorable but not long-lived.

Incentives created by the newly-signed housing bill HR 3221 are designed to provide a quick shot to the housing market and may not be around long. Effective immediately, there is a first-time buyer credit (which others not technically “first-time” buyers may qualify for as well) of $7500, but it expires July 1, 2009. Conforming, FHA, and VA loan limits, which were raised as part of the economic stimulus package, will drop in many areas, although the new law raises the limits somewhat higher than limits in place before the stimulus package passed.

In addition, interest rates have been inching up. While still relatively low, many economists feel that rates are far more likely to increase than decrease in the coming years. And while buyers can’t be absolutely certain that the housing market has completely bottomed out, most experts say that the only way you know prices have hit bottom is when they rebound–and at that point its too late to take advantage of it.

What today’s buyers can take advantage of are lower home prices, fairly low mortgage rates, tax relief, and higher loan limits (meaning lower prices and greater availability for financing). If you can afford it and home ownership makes sense, you may never find a better time than the present to make a solid investment.

Fannie Mae’s new initiative, dubbed “Keys to Recovery” looks great at first blush. Those with mortgages underwater can refinance them, up to 120% of the current home value. Wow.

 But a closer look shows this isn’t the rescue effort it appears to be. First, the loan has to already be on Fannie Mae’s books, and the refinance has to improve the borrowers’ position, either by fixing their adjustable rate or lowering the payments. But Fannie Mae loans haven’t been the main source of borrower misery in this country–people in Fannie Mae loans aren’t having the payment shock and other problems others have had because these people qualified for prime loans at conventional terms. And rates and indexes haven’t gone up all that much. So, Fannie Mae is taking a loan it owns and making it a little less likely to end up in default. And using the PR to paint it as some kind of ‘rescue’ effort.

 Maybe for its own shareholders…..