Questioning the Fairness of Tax Structures in Real Estate for Single Family Homeowners - (2024)

In an overall top down view of residential real estate, specifically owner occupied homeownership, the disparities in tax treatment between landlords and typical homeowners are profound and worth examining in detail. As John Schink, Managing Broker of Deerwood Realty, astutely observes, “It does seem like now is the time to really take a look at the disparities between pro investors and single-family homeownership. The tax structure would be the easiest way to change this behavior.” This echoes the insights of John Wake from realestatedecoded.com, who sheds light on how certain tax breaks for landlords distort the housing market, making homeownership more challenging and contributing to economic inequality.

Here’s a breakdown of the key tax breaks that landlords enjoy, which are generally not available to typical homeowners:

Depreciation Tax Deduction: Perhaps one of the most significant disparities lies in the depreciation tax deduction. This provision allows landlords to deduct the cost of their property over time as it depreciates on paper. However, in reality, many properties appreciate in value, making this a particularly beneficial arrangement for landlords. It essentially enables them to claim a reduction in property value even as the market value may be increasing.

1031 Exchange Tax Deduction: The 1031 exchange is another tax tool favoring landlords. This provision allows them to defer capital gains taxes when selling a property, provided they reinvest the proceeds into another property. This can be repeatedly done, potentially allowing landlords to avoid capital gains taxes indefinitely, as long as they continue reinvesting in real estate.

Mortgage Interest Tax Deduction: Landlords can also deduct the interest they pay on mortgages for their rental properties. While homeowners can also deduct mortgage interest, the benefit for landlords is amplified when combined with other real estate-specific deductions and the fact that they can claim this on multiple properties.

Tax-free Landlord Profit-Taking: Another notable disparity is that landlords can take profits from their rental properties tax-free under certain conditions, while homeowners have to pay taxes on profits from selling their homes. This creates an uneven playing field, especially when considering the scale of investment and profit potential between individual homeowners and professional landlords.

Lower Taxes on Capital Gains: Capital gains taxes, which are typically lower than ordinary income taxes, benefit landlords when they sell properties at a profit. This lower tax rate means that landlords retain a larger portion of their profits compared to what they would if these gains were taxed as regular income.

Stepped-up Tax Basis: The stepped-up tax basis is a significant benefit for landlords’ heirs. When a landlord dies, their heirs inherit the property at a stepped-up basis, meaning they can sell it without paying capital gains taxes on the appreciation that occurred during the original owner’s lifetime. This provision not only benefits landlords during their investment journey but also extends financial advantages to their heirs.

In addition to these tax breaks, there are other factors at play exacerbating housing market distortions, here are a few:

1. Restrictive Zoning Laws: Zoning laws significantly influence where and what can be built. In many areas, these regulations limit the construction of multi-family housing like apartments or condos, contributing to housing shortages and driving up prices, particularly in high-demand urban areas.
2. Landlord Dominance in Setting Rental Prices and Terms: Landlords hold significant power in the rental market. They set the terms and prices for rentals, often with limited regulatory oversight. This control can lead to inflated rental prices, making it challenging for renters to save for homeownership.
3. Investors Buying Up Single-Family Homes: The trend of investors purchasing single-family homes for rentals or resale has escalated home prices. This practice often prices out first-time and individual homebuyers, as investors can pay cash and buy in bulk, skewing the market in their favor.
4. NIMBYism (Not In My Backyard): NIMBYism reflects the opposition of local residents to new development, particularly affordable or high-density housing, in their neighborhoods. This attitude can stall or stop new housing projects, exacerbating the shortage of affordable housing options and limiting market growth.

To rectify this imbalance and promote a more equitable housing market, there’s a need for policy reform. This could include restructuring tax breaks to level the playing field between landlords and homeowners, reforming zoning laws to increase housing availability, and implementing strategies to counteract investor-driven price inflation. By addressing these issues, the government could foster a housing market that is more accessible and fair, ultimately helping more people achieve homeownership and financial stability.

As we navigate the complexities of the housing market, it’s important to remember that the market itself often finds a way to balance out. While the current advantages for professional landlords might seem overwhelming, the ‘invisible hand’ of the market is always at play. If the return on investment for landlords diminishes, we could see a natural shift in the market dynamics. This could lead to opportunities for more equitable housing practices and increased homeownership. It’s a reminder that market forces, combined with thoughtful policy interventions, can drive positive change. As we move forward, there’s every reason to stay optimistic about the market evolving towards greater affordability, ensuring that the dream of homeownership becomes a realistic goal for more people.