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'Cash for Clunkers' vs. 'Cash for Renters'

As the recession wears on, Uncle Sam is sending America a message loud and clear: SPEND! Of course, with the U.S. Economy directly tied to the health of the automotive and real estate industries, it makes sense that Americans are being incentivized to rush out and buy the new car or house of their dreams (or at least a resemblance of their dreams depending on how closely aligned their tastes and budgets are).

"Cash For Clunkers," one of the two heavily promoted government programs, resulted in the sale of nearly 700,000 new cars in just a few weeks, providing a face lift to driveways and rush hour traffic everywhere. The program sparked new car sales by offering a guaranteed tax credit of either $3,500 or $4,500 in exchange for trading in your old jalopy. The actual amount depended on the current gas mileage of the car to be traded in and the improvement in gas mileage with the new car being purchased. So, if you had a gas guzzling eyesore that you would be lucky to get  $500 for under normal circumstances, "cash for clunkers"  was calling your name!

In addition to the immediately applicable tax credit that effectively reduced the price of the new car being purchased, state sales tax paid on the new car may be deductible on your 2009 federal tax return. However, deducting the sales tax is a one time event and truly does not provide much relief. For example, if you purchased a car that cost $25,000 and live in Los Angeles, the sales tax would be $2,437.50. So, if you are in the 28% tax  bracket, your effective tax benefit for 2009 would be $682.50 (28% of $2,437.50).

Of course, something is usually better than nothing but experts are concerned that while "cash for clunkers" did in fact result in a temporary stimulus of our economy and take a lot of fuel inefficient cars off the roads, the bottom line is that Americans have saddled themselves with more debt in exchange for depreciating assets. Consider the 2010 Toyota Camry XLE . According to the depreciation calculator on Edmunds.com, the moment, you drive this car off the lot, it loses over $7,000 in value. What's more, because the burden of collecting the tax credit from the government was given to the dealers, if a potential buyer mentioned that they had a "clunker" to trade in before the price of the new car had been negotiated, it is questionable as to whether or not the dealer truly delivered the best price to the buyer on the new car.

The other program that we will look at is "cash for renters" (officially a provision of the American Recovery and Reinvestment Act awarding first-time  buyer a federal tax credit of up to $8,000 for homes purchased between January 1, 2009 and November 30, 2009) . To qualify, you cannot have owned a primary residence in the last 3 years and must be below certain income thresholds. This program was originally introduced in 2008 but the tax credit amount was slightly less and the credit had to be repaid over time. For 2009, the government has sweetened the deal and eliminated the repayment clause so the money is yours to keep provided you stay in your home at least 3 years.

Unlike "cash for clunkers" the first-time buyer program shifts the responsibility of claiming the tax credit to the buyer. This eliminates any uncertainty over the merit of the deal because the seller is not impacted by whether the buyer qualifies for the tax credit or not and therefore only has to confront current market conditions when coming up with a price.

Another benefit of the "cash for renters" program is that under the current tax laws, the tax benefits last as long as buyer owns the home. Even if the mortgage is eventually paid off, the property taxes are still deductible. For someone purchasing a home in Orange County, where the median sales price for July was $420,000, it means an approximate $5,000 tax deduction for the property taxes alone for as long as the home is retained.  

Of course, there is no guarantee that real estate will not lose value. The last two years have been a painful reminder of that to many. But, according to stats posted on Freeby50.com, from 1890 to 2007, real estate has appreciated by an average of 3-4%. While that does not beat the historical averages of the major indices on Wall Street such as the S&P 500, it obliterates the return on just about any car. Plus, with prices having come down in many areas to levels not seen in a decade, interest rates at historic lows and the government offering huge incentives, there is a tremendous opportunity for buyers to enter the market. 

Those who don't take advantage now will ultimately be able to afford less when interest rates rise which could mean that they are priced out of the market entirely. Most people fail to realize that a 1% increase in interest rates is equivalent to a 10% increase in home prices. For example, if you are looking at a home that is $400,000 today and rates are at 5%, if rates go to 6%, it would be like you were paying $440,000 for that same house. Another way to think about it is that if rates rise by 1%, home prices would have to fall another 10% to create an equilibrium. So taking that same example, if you can afford $400,000 today at 5%, when rates go to 6%, your affordability decreases to $360,000.  

Ultimately though, while all of the aforementioned factors ought to be considered, the reality is that as a first-time buyer, your first house is so much more than just the building on top of the land, the rock bottom deal you can get, or how much equity you can hope to amass. Your first house represents a sense of accomplishment, a place to hold gatherings for friends and relatives, a place to start a family; it is, after all, your home.

 NOTE:  The illustrations in this article are not intended as tax advice. As always, please consult your tax professional.

Comments

  • Jonathan Klein 5 years ago

    Matt, great job!

  • Trinidad 5 years ago

    I loved how you portrayed that a house is a home and how you illustrated the tax benefits of ownership. Very enlightening.

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