Articles

Restructuring the Tax Treatment for Home Equity Draws: Implementing Consumption Tax Fundamentals to Preserve Home Equity

Allan H. Holzer, Loyola Law School Los Angeles

Abstract

Home ownership was once the quintessential sign of financial success in America. This is no longer the story. The current strain on the United States economy began with imprudent lending practices. Financial innovation in the mortgage industry allowed lenders to develop lending options to uncreditworthy borrowers. The subprime loan industry lent to borrowers who lacked the financial wherewithal to afford a home mortgage. Creative loans, coupled with low interest rates, sparked demand in home purchasing. Real estate values soared and homeowners began to amass significant amounts of home equity. Instead of amassing this wealth for retirement, Americans discovered ways to extract this equity through cash-out refinancing and home equity lines of credit. Imprudent borrowing caused the financial demise of many Americans.

In this article, I address the current tax-free treatment of home equity withdrawals and address how our tax law fails to promote homeownership as a long-run personal savings mechanism. Finally, I propose a modification to the Internal Revenue Code that would use consumption tax attributes to curb wasteful home equity withdrawals. This system would use the Internal Revenue Code to restrict homeowner’s withdrawal of home equity to socially favored usages. Modification to the tax treatment of home equity would create a disincentive for individuals to casually extract equity and reinstate homeownership as a long-run personal savings mechanism.

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