What does the tax bill mean for your real estate? The National Association of Realtors, typically an optimistic group of folks 😊 , says: “The direct result of these changes would be a plunge in home values across America in excess of 10 percent, and likely more in higher cost areas.” (NAR). Furthermore, “with the higher standard deduction, the math turns the decision to buy or rent upside down from current conditions”, said Trulia’s McLaughlin. Is real estate really headed for a cliff? Will the tax bill “greatly disincentive buying homes”? (Reuters) Four changes to watch in the new tax bill that will impact everyone in real estate.
What are the big changes in the tax bill?
There are four major changes in the tax bill that will impact every property owner in some way. The true impact will be dependent on your personal circumstances including where you live, your house value, income, etc… Before discussing the ultimate outcome of whether the realtor’s association is correct that property values will drop, it is important to understand what each of these changes actually does for the property owner. The four major changes are:
- Raises of the standard deduction to 24,700 for married couples (double the current amount)
- Increasing the standard deduction greatly reduces the number of people that will file itemized deductions. In the past, typically the largest itemized deduction was for mortgage interest. Under the current scenario most homeowners would be better off taking the standard deduction as opposed to itemizing since there mortgage expense is less than the standard deduction. In a nutshell, renters and homeowners get the same “benefit” from the standard deduction and there is no longer a tax advantage for most homeowners to itemize.
- Cap on amount of mortgage interest that is deductible (drops from 1m to 750k)
- This will be especially impactful in high cost areas where median home prices are well above the 750k threshold. The past cap was 1m, so the reduction of 250k of interest could result in tax increases for homeowners at this price point
- Elimination of deduction of interest on Home equity lines of credit
- Under the current law you could deduct interest from Home Equity Lines of Credit from your personal taxes. This was a very cost-effective financing mechanism for home remodels, pulling out cash for other investments, etc…
- Cap of 10k on deductions for state/local taxes
- Currently you can deduct all of your state and local taxes. Under the new proposal there would be a cap on the deductions. This will have a huge impact in high tax areas. For example, property taxes alone on the median home in many NY and CA counties average over 14k, that doesn’t even include income taxes!
What do the changes mean?
How will the changes above flow through the real estate market and ultimately impact pricing? Will some changes impact prices more than others? What will homebuyers/sellers do as a result of the above?
- Will you sit tight?
- One item that many reporters have missed is that one impact of all these changes will be that many property owners sit tight and do nothing. If you bought a property before 12/31/17 you are grandfathered in under the old tax rules. You can deduct 250k more on your mortgage. Along with a higher deduction, your interest rate is likely a good rate as well since mortgage rates are trending higher because of this tax legislation. This idea of many borrowers sitting tight will crimp the supply of properties in many higher cost areas.
- Will more expensive homes decrease in value?
- It will now be harder to qualify for a mortgage on higher valued properties. The mortgage deduction will be less and therefore your taxable income could be higher. Banks will factor this into their approvals which will make getting a jumbo loan harder. If a borrower were a marginal borrower trying to move up, they might not get qualified now. With the higher holding costs will borrowers “shy away” from more expensive properties? In certain areas this could be a possibility, but I don’t think this will be a widespread outcome.
- Will people no longer be “incentivized” to buy homes as suggested by the National Association of Realtors?
- This is an interesting question. In the past home buyers got preferential tax treatment by being able to deduct their mortgage interest. Under the new plan, for the majority of home owners, the standard deduction will be more beneficial than itemizing. Non-property owners will therefore have the same tax status as property owners. This makes the rent verse buy decision more difficult
- Will people flee high cost areas?
- The tax burden in many high cost areas will rise since you can no longer deduct all of your taxes. Not only do homeowners in these areas pay higher property taxes, these taxes will no longer be deductible leading to even more financial burden from taxes.
What is going to happen because of the changes?
Predicting human nature is always difficult. A home to many buyers is much more “emotional” and not just a dollars and cents decision. In economic terms people likely will not act in the predicted “rational” fashion.
Due to the “irrationality” of consumers, I think that the actual impact to real estate from the changes will be nominal. People are still going to buy houses and I am doubtful you will see much decrease in the value of houses. Ironically you could see the opposite. With uncertainty many people react with the “deer in headlights” mentality and decide to do nothing. This will actually decrease the available supply and could cause prices to further increase in certain markets.
The National Association of Realtors should continue with their tried and true optimism that they are well known for. The sky is not going to fall on real estate from the proposed changes.
Sources: Additional reading
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
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