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Years of rapid home price appreciation along the northern Front Range will leave homeowners in the region more vulnerable to changes in the tax code now before Congress.
Coloradans need to be aware of one change in particular that could have big implications for them when it comes time to sell — an extension in the time owners must occupy their homes to avoid paying capital gains taxes.
“Homeowners across the country should pay attention. You will find the biggest effects, however, in your biggest, more expensive markets,” said Danielle Hale, chief economist with Realtor.com.
Right now, owners must have lived in a home for at least two years within the last five years at the time of sale to avoid paying capital gains taxes on any increase in value up to $500,000. For most homeowners, that means holding on to a home for at least two years is a good idea.
But Congress, looking for ways to generate more revenues to pay for cuts elsewhere, wants to extend that to five years within the last eight years. That would force most homeowners to wait five years or more to avoid a tax penalty that could reach into the tens of thousands of dollars.
Much attention has been paid to proposed caps on deductions for mortgage interest and property taxes, differing versions of which are included in the Senate and House plans. While that change may only affect wealthier homeowners, it could lower home prices across the broader market and push second-home owners in places such as Colorado’s high country to sell.
But the change that will have the greatest impact on average homeowners is likely to be the longer holding period required to avoid capital gains taxes, said Lou Barnes, a senior loan officer with Premier Mortgage Group in Boulder.
“This one will surprise people. People will sell homes and not realize they have left the safe harbor. They will wind up with a large tax obligation,” Barnes said.
Owners with a tenure of between two years and five years accounted for roughly one in five home sales in metro Denver and Boulder over the past 18 months, according to statistics provided by Black Knight, a mortgage analytics firm based in Florida.
And according to HSH.com, Denver is the country’s “most recovered” large metro housing market, with a federal home price index 72.3 percent above the peak reached last decade before the housing crash.
The median home price in Boulder is around $516,000 as of August and $392,000 in metro Denver, according to the Black Knight home price index.
Sellers in metro Denver had an average profit above their initial purchase price and other costs of $110,000, while those in Boulder pulled down profits of $150,000. Nationwide, the average gain on sale is around $80,000.
Up to $22,500
Capital gains tax rates vary based on income, but in the middle brackets they run 15 percent. That would translate into $16,500 in additional taxes in Denver and $22,500 in Boulder on a typical sale.
“Any capital gains will likely be felt to a higher degree in Denver and Boulder,” said Andy Walden, Black Knight’s director of market research.
Because the current rules on capital gains on a home sale are so accommodating, few people pay attention to them, Barnes said. Most homeowners will stay in a home at least two years, and those who do sell before that will not see as much appreciation, keeping the capital gains tax lower.
Under the proposed tax plan, if a real estate agent or accountant doesn’t warn a seller, or they don’t hear a horror story from someone hit with a huge tax bill, they risk falling into a trap.
Some sellers may not realize their obligations until they sit down to prepare taxes the following year, long after they rolled any proceeds into the next home, Barnes said.
That means owners, to the degree they can do so, will need to stay in their homes a minimum of five years. That creates another complication for the market.
The larger metro Denver area, with a population of 2.8 million people, had just over 5,000 homes available for sale at the end of November, according to the Denver Metro Association or Realtors.
Not only is that at a record low for the month of November, it is one-third of the normal inventory over the past two decades for the month.
“If any Denver home sellers decide to delay or forego home selling, this would also continue to constrain for-sale inventory,” said Walden.
Tax deduction changes
While changes to the capital gains holding period are an issue consumers need to plan for, there is less agreement on what more limited tax deductions for property taxes and mortgage interest will mean for housing.
Among the changes being hammered out in a reconciliation process between House and Senate tax plans is an elimination of deductions on property taxes paid above $10,000 and on the interest on mortgages amounts above $500,000.
Colorado has some of the lowest property taxes in the country, so the $10,000 cap isn’t as big an issue here. But given how much prices have risen, homes values topping $500,000 are becoming more common.
In the Denver-Aurora-Lakewood area, about three-quarters of homes have a mortgage on them. Of those, just over a fifth have a value of $500,000 or higher.
In Boulder, seven in 10 homes carry a mortgage, and of those, just under half are valued at $500,000 or more, according to Realtor.com
A home price above $500,000, however, doesn’t mean the mortgage is that large, given down payments and the monthly principal paid.
Less than 4 percent of active mortgages in metro Denver and 8 percent in Boulder actually have a balance that high, according to Black Knight.
Given the run-up in home prices, about 8 percent of homes purchased last year had a mortgage balance above $500,000 in Denver, while 23 percent of new Boulder mortgages were that large, said Walden.
The proposals will grandfather those who already have a mortgage above the limits, softening the impact.
Also, households making above $250,000 a year already face limits on the deductions they can claim, said Barnes, who views warnings about home prices falling as overblown.
The National Association of Realtors (NAR) argues the loss of real-estate-related deductions could cost homeowners $1,000 more on average in taxes while providing renters a savings of $500.
“The NAR is predicting home prices could fall from 7 percent to 11 percent (in Colorado) if both the mortgage interest and real estate taxes deductions are eliminated,” said Steve Thayer, chairman of DMAR and owner of Keller Williams Action Realty in Castle Rock.
That would translate into the typical homeowner in Colorado losing home equity in the $24,000 to $36,000 range, Thayer said.
The mortgage interest deduction on second homes, which account for about 5 percent of the state’s housing stock, is also on the chopping block.
In some mountain resort counties, the share of vacation homes can run 30 percent to 40 percent higher.
Hale said she expects more people will convert their second homes into rentals so they can claim the mortgage interest and other deductions they will otherwise lose.
That would make more rentals available to accommodate more tourists, whose spending would give resort economies a boost.
But that added inventory, combined with the loss of tax breaks that helped offset the cost of having a second home, could discourage new construction.
That would harm resort economies, more so second-tier markets such as Breckenridge and Grand County that rely on Front Range buyers rather than the stomping grounds of the wealthy including Aspen and Telluride.
Glen Weinberg, chief operating officer Fairview Commercial Lending in Steamboat Springs, said on his daily lunchtime jog, he has noticed more vacation homes coming up for sale.
People could be disappointed with the paltry snow or just making year-end financial moves. But the surge coincides with the Congressional wrangling over tax reforms.
His take is that some owners are trying to get ahead of what they perceive as a downturn in the second home market, he said.
“What does this mean for the second home market? It will be fascinating to see what happens,” he said.