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Sunday, September 28, 2008

Did § 121 Contribute to the Financial Meltdown?

The Tax Foundation, Cafe Hayek, and Don't Mess With Taxes all finger § 121, which was enacted in 1997 and allows married taxpayers to exclude $500,000 of gain (single taxpayers can exclude $250,000 of gain) on the sale of a primary residence or vacation home every two years, as a significant contributor to the current financial meltdown.  Check out this New York Times chart on housing prices before and after the enactment of § 121:

Caseshiller

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Comments

Nonsense, a classic post hoc ergo propter hoc error. Enactment of section 121 hurt homeowners. It replaced the prior § 1034 tax free rollover which was just as favorable for most people, and better for many because it was unlimited in the amount of gain that could be deferred by trading up to a more expensive home. Withdrawing gains from the housing market tax free - the only advantage of § 121 over former law - would have cooled the housing market, not heated it up.

Posted by: Richard Beck | Sep 28, 2008 12:59:28 PM

Section 121 clearly added somewhat to the bubble in the $150k to $500k price range. Buyers in that range had visions of tax-free profits.

At the high end, the lack of indexation of Section 121's limits ($500k was HUGE in 1997's real estate market) constrained the bubble somewhat. Inflation will bring more and more homeowners into a situation in the which the federal government claims up to 22% of their home's value on sale.

On balance, Section 121 was probably a minor factor increasing the bubble, more notable for its effect on buyer's decisions than any direct financial benefits.

Posted by: AMTbuff | Sep 28, 2008 5:37:25 PM

But the 2-of-5 lookback liberalized the old principal residence rules, right? (It was before my time.) Thus 121 would have encouraged buying a second home and then flipping the original.

Posted by: Apep | Sep 29, 2008 6:43:30 AM

the chart is bullshit.

based on this bullshit chart, homes purchased in 2003 could have been sold for a 100% gain in 2006, which was not the case at all.

Posted by: Jojo | Sep 29, 2008 11:08:52 AM