By Samantha Sharf, Forbes.com
Three days before Christmas 2017, President Donald Trump signed the Tax Cuts and Jobs Act into law. The bitter political fights that led up to the bill’s passage may be over, but the work of interpreting the legislation has just begun.
So what does it all mean for housing? For some homeowners, net after-tax housing costs will increase under the new law. Renting may become relatively more attractive for those on the fence about becoming homeowners. And people still determined to buy may find the supply of homes on the market has dried up. How exactly the tax overhaul will affect you and your housing options will depend on where you live, how much you spent (or can spend) on your home and how much the bill decreases (or increases) your overall tax burden.
Here is a brief roundup of the provisions in the new law that could directly impact your home or the housing market in your area.
The mortgage interest deduction: If you buy a home between now and 2026, you can deduct the interest on up to $750,000 in mortgage debt used to purchase or improve it as an itemized deduction. This cap affects home purchases made after December 14, 2017. Anyone who took out a mortgage on December 14 or earlier will be able to deduct interest on up to $1 million in debt, the old cap, for that home, even if they refinance to get a lower rate. (Note that prior to the new law, interest on up to $100,000 in home equity debt taken to improve a home was also deductible, which the IRS interpreted as meaning that interest on a mortgage of up to $1.1 million could be claimed. The new legislation wiped out the deduction for home equity debt, including on existing loans, beginning in 2018. You can still claim it for 2017 when you file your taxes this April.) Barring new legislation, in 2026 the law will revert to its prior state, with interest on up to $1.1 million in mortgage and home equity debt again deductible.
Since most homes in this country are worth far less than $750,000, this change alone will not increase housing costs for the majority of home buyers. There are some buyers, however, particularly those who live in expensive housing markets along the coasts, who will be hurt. Moreover, by treating current homeowners better than future buyers, the law creates a disincentive for people already in million-dollar homes to move. It will also give those thinking about trading up to homes costing more than $750,000 a reason to reconsider, likely constraining the already tight supply of less expensive homes.
State and local tax deductions: Under the old tax law all property taxes paid to state and local governments could be claimed as an itemized deduction. (Assuming one didn’t pay the alternative minimum tax.) It was also possible to deduct state and local income or sales taxes. The new law bundles all these so-called “SALT” taxes together and limits the deduction, in total, to $10,000 for both individuals and married couples.
For some homeowners in high-tax areas such as New York, New Jersey, Connecticut, Maryland and California, $10,000 does not come close to covering their combined property and income tax bills. There was, unsurprisingly, a rush by homeowners to prepay property taxes for 2018 so they could be deducted on 2017 taxes. Some of those prepayers may be disappointed. The IRS said on December 27 that only those 2018 taxes that had already been assessed were eligible for prepayment.
Now some state governments are looking for creative workarounds for 2018 and beyond. For instance, since the new law did not limit charitable deductions, legislation introduced this week in the California State Senate, for instance, would allow residents to make charitable contributions to the state instead of tax payments. It is unclear if this will work legally. Another idea New York has been toying with involves replacing state income taxes with payroll taxes.
Bringing it all together: Even if the SALT and mortgage-interest changes do not impact you directly, do not assume your net after-tax housing costs will remain the same. The new law roughly doubles the standard deduction to $12,000 for an individual filer and $24,000 for married couples filing jointly. For many couples, the increase in the standard deduction will cancel out the benefit of itemizing, since their mortgage interest and $10,000 SALT deduction combined, won’t exceed $24,000.
An analysis by home search and data firm Zillow found that just 14% of homes in the U.S. are worth enough, and carry high enough tax bills, that a new buyer, borrowing 80% of the purchase price, would benefit from itemizing–that is deducting mortgage interest and taxes. Under the old tax setup 44% of homes were worth enough for buyers to itemize.
Yes, you could argue that money is money, so it does not matter whether tax savings come from an itemized or standard deduction. Nevertheless, eliminating the tax incentive to buy a home is a major shakeup to residential real estate industry–not to mention to a culture that has long glorified homeownership. Some smart people, however, have pointed out homeownership might not be the economic salve it’s cracked up to be and that if reduced tax benefits do lower home prices (as the National Association of Realtors predicts), first-time buyers could come out ahead.
A dodged bullet: Despite some battle wounds, real estate professionals broadly agree: It could have been worse. Earlier versions of the tax plan eliminated property tax deductions entirely and cut the mortgage-interest cap even further. But the biggest win for the industry may be that the final bill maintains the exclusion for capital gains from the sale of a primary residence. This means a taxpayer who sells a home may exclude up to $250,000 of gain from taxation ($500,000 if married filing jointly) if he or she has owned and used the home as a primary residence for two of the past five years. Earlier versions of the bill would have increased the ownership and use requirements to five of eight years, and kept higher-income taxpayers from claiming the exemption at all.