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The New American Nightmare: A UB Law School professor examines the causes, solutions of the American home foreclosure crisis

Release Date: January 14, 2009

BUFFALO, N.Y. -- Stuart Lazar, an associate professor in the University at Buffalo Law School concentrating in tax law, has expertise and insight into the new American nightmare: losing your home. Before he became a professor, Lazar was a tax lawyer representing both individuals and businesses in the tax planning process. Lazar -- a homeowner and an investor in residential real estate -- believes that failures in the housing market triggered the overall financial crisis; and that the general economy will never recover unless the downward spiral in real estate prices stabilizes.

"None of the attempted solutions passed by Congress and the Bush administration has solved the problem," says Lazar. "And, in my opinion, none will until we deal with the housing problem. The government's attempts to address this portion of our financial difficulties have been, at best, modest. Whether they have any significant effect on the problem remains to be seen."

UB: You've stated your strong belief that the current national financial crisis all began with a failure in the housing market. Can you elaborate on what you mean.

LAZAR: The current financial mess that we find ourselves in has its origins in an asset price bubble -- an increase in housing prices -- fueled by heavily leveraged loans in which borrowers put little or no money down to purchase real estate that they could not realistically afford; the creation of new kinds of financial innovations (such as mortgage-backed securities) that masked the true risk in the market; lenders that made loans without income verification (so-called "liar loans"); regulators who failed to regulate the banking industry, and a Congress that encouraged irresponsible lending (through the Community Reinvestment Act).

All of the above factors have contributed to real estate markets that have become artificially inflated -- especially the housing market, as home prices across the country increased each year. Prices rose faster than the fundamentals would have suggested -- out of line with increases in household income and significantly above the rate of inflation. Typical of asset bubbles, there was an expectation of future price increases. This led to further price increases as individuals saw real estate as a no-risk investment. It also led to situations where individuals would borrow against these price increases in the form of refinancings and home equity loans.

UB: Sounds like a problem waiting to happen?

LAZAR: It was. An asset bubble is like a Ponzi scheme. Homeowners purchased or borrowed against their homes with the expectation that a future group of buyers would pay increasingly rising prices. When the economy began to slow, and prices stopped rising, new buyers were not there waiting to bail the existing homeowners out. Those who could not afford to pay mortgages that they never should have received in the first place began to default. This led to the beginning of a decrease in housing prices, which affected additional homeowners, leading to the current downward spiral.

UB: So, who is to blame?

LAZAR: Everybody. Borrowers who shouldn't have borrowed. Lenders who should not have lent. Regulators asleep at the switch. And legislators who allowed the crisis to occur, and had no plan to stop the crisis. Many people recognized that a bubble was being created, but no one acted to prevent it. The slower economy acted as the pin to puncture the bubble.

UB: As a tax lawyer, do you believe that the solution is found in our tax laws?

LAZAR: There isn't any one solution. However, Congress has attempted to use the tax laws to try to stimulate the housing market and help existing homeowners.

UB: How?

LAZAR: A couple of measures have been passed recently. One allows first-time home buyers a refundable tax credit equal to the lesser of $7,500 or 10 percent of the purchase price of a principal residence. The credit is available for qualifying purchases made between April 9, 2008, and July 1, 2009. For these purposes, a first-time home buyer is defined as a buyer who has not owned a principal residence during the three-year period prior to the purchase. For married taxpayers, the homeownership history of both spouses is examined. Only if neither spouse has owned a principal residence during such three-year period will the parties qualify for the credit. Ownership of a vacation home or rental property not used as a principal residence does not disqualify a taxpayer for the credit.

The term "tax credit" is misleading, however, since it is required to be repaid. Home buyers will be required to repay the credit, without interest, over a 15-year period (at a rate of $500 per year) or earlier, if they sell the house (to the extent of any profit upon sale). Repayment does not begin until two years after the credit is claimed -- so if the credit is claimed on a taxpayer's 2008 tax return, repayment begins on the taxpayer's 2010 tax return. When the home is sold, any credit not previously repaid must be repaid from the profit on the sale. If there is insufficient profit, the remaining credit amount would be forgiven. Since the credit is required to be repaid, taxpayers may think of this incentive more like a zero-interest loan than a traditional tax credit.

In essence, Congress believes that fronting money to first-time home buyers will bring more buyers into the market. More buyers should lead to increased demand. Theoretically, this increased demand should help to increase -- or, at the very least, stabilize -- home prices.

UB: How can eligible taxpayers claim the tax credit?

LAZAR: Taxpayers that qualify claim the credit on their federal income tax returns. And the credit is refundable -- meaning that taxpayers owing less than $7,500 in federal taxes will be entitled to a tax refund for the difference. Taxpayers that qualify for the credit as a result of a home purchase in 2009 can accelerate the credit by treating the purchase as occurring in 2008, and by claiming the credit against their 2008 tax liability. This gives taxpayers the ability to determine when the credit would yield a larger benefit.

UB: Are there any limitations on taking the tax credit?

LAZAR: There are, both in terms of the amount of the credit and which taxpayers can qualify. First, the full amount of the credit is available to single or head-of-household taxpayers with a modified adjusted gross income of no more than $75,000, and married taxpayers with a modified adjusted gross income of less than $150,000. The credit is phased out by $375 for each $1,000 by which the taxpayer's modified adjusted gross income exceeds such limits. As a result of this limitation, single or head-of-household taxpayers with a modified adjusted gross income of $95,000 and above, and married taxpayers with a modified adjusted gross income over $170,000, are not entitled to any tax credit. Second, the credit is limited to 10 percent of the qualified purchase price. Taxpayers that purchase a home for less than $75,000 will be limited by this percentage limitation.

UB: The first-time buyer credit helps buyers. What about existing homeowners?

LAZAR: Two new tax provisions help existing homeowners.

As a general rule, debt that is forgiven or canceled by a lender must be included in income on a taxpayer's tax return. However, the Mortgage Forgiveness Debt Relief Act of 2007 has a provision that allows taxpayers to exclude from income amounts realized as a result of modification of the terms of a mortgage or a foreclosure on a principal residence. The act only applies to debt taken out to purchase or construct a principal residence, not to home equity debt. The intent of the act is to help those taxpayers who have lost their home, or to help those taxpayers able to renegotiate with their lender in order to keep an existing home. Combined with another bill passed in 2008, mortgage debt forgiven from 2007 until 2012 will be excluded from income.

Second, as a general rule, state and local property taxes are only deductible when taxpayers itemize their tax deductions. However, beginning with the 2008 tax year, a new standard deduction of $500 ($1,000 for married taxpayers filing jointly) will be available for these taxes.

UB: OK, Professor Lazar, is there anything that taxpayers need to know about these new provisions?

LAZAR: As with all tax provisions, there are limitations and exceptions to the rules stated above. Taxpayers wishing to learn more about these provisions should consult their own tax advisers or may receive additional information at the IRS Web site (http://www.irs.gov).

UB: So, will these tax provisions "fix" the housing crisis?

LAZAR: In my opinion, not by a long shot. These provisions will make a difference for some taxpayers, but more work needs to be done. Congress needs to provide further incentives for home buyers and investors, and find a way to get banks lending again. In addition, much more is needed to help existing homeowners.

Remember, that even with foreclosure rates at these historically high levels, and even more taxpayers going into default on a daily basis, approximately 95 percent of all mortgagees continue to make their mortgage payments on time. For government action to have any significant effect, Congress will need to provide a stimulus to incentivize these responsible citizens to continue to carry out their contractual obligations with their lenders. That, however, is an entirely different conversation.

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