The enormity of this change has not been fully appreciated just yet.
The tax bill now becoming law will impact the housing market in a big way via four mechanisms that gut the government’s subsidies of homeownership:
- Nearly doubling the standard deduction (but wait…)
- Lowering the cap on the mortgage interest deduction for new purchase mortgages
- Capping the deduction for state and local taxes at $10,000
- Eliminating the deduction for interest on home-equity debt, such as HELOCs.
The Big Equalizer: The New Standard Deduction
Nearly doubling the standard deduction – from $6,350 for individuals and $12,700 for married couples filing jointly in 2017 to $12,000 and $24,000 respectively in 2018 – would be a simple way of giving many Americans an instant, massive, no-hassles tax cut.
But wait: The law also eliminates the personal exemption of $4,050 allowed for each family member. A married couple will see an increase in the standard deduction of $11,300 (compared to 2017). But it will lose $8,100 in personal exemptions. This whittles down the net increase in deductions to $3,200. For couples with kids, it gets more complicated.
But whatever this does, it moves all of the up-front deductions and exemptions into the calculus that taxpayers routinely make: Should they use the standard deduction or itemize?
In other words, can a married couple filing jointly come up with over $24,000 in deductible expenses, such as mortgage interest? If the answer is no, they will benefit from the new tax law by taking the standard deduction, instead of itemizing and deducting their mortgage interest. And they’ll come out ahead.
Currently, about 44% of US homes are worth enough to carry a mortgage whose interest would be large enough to surpass the old standard deduction, and thus would incentivize homeowners to take the mortgage interest deduction by itemizing, according to Zillow. With the new standard deduction, this proportion of homes drops to 14.4%.
This effectively guts one of the most widely touted government subsidies of homeownership. It levels the playing field between renting and owning. In fact, it’s a particularly big benefit for renters. It’s the great equalizer.
Since it benefits so many households and hurts none of them, it’s devilishly hard to argue against. Nevertheless, the immensely wealthy and powerful lobbying group, the National Association of Realtors – whose constituents make more money when homes churn often and when prices surge – has lobbyied fiercely against it. And it lost.
A Sucker Punch for Expensive Markets
The mortgage interest deduction was already limited to interest on mortgages of up to $1 million. This cap has now been lowered to $750,000, but the cap only applies to new purchase mortgages, not existing mortgages.
Most Americans won’t feel it. Their mortgages are not nearly big enough. Only about 4% of purchase mortgages made in 2017 exceeded $750,000, according to Attom Data Solutions, cited by the Wall Street Journal:
But a few regions would get hit hard. In Manhattan, for example, 64% of purchase mortgages made this year were for more than $750,000, according to Attom. In San Francisco, that proportion is 58%, and the surrounding counties of San Mateo, Marin and Santa Clara register between 44% and 55%.
Black Knight Inc., a mortgage data and technology firm, calculates there are about 684,000 active mortgages with current balances over $750,000. Black Knight estimates that about 107,000 loans expected to be made in 2018 would fall above the $750,000 cap.
So in many markets, the impact of this provision will be small. In expensive markets, the impact could be significant in various ways, including:
- Homeowners might stay put in order to maintain the deductibility of their original mortgage of up to $1 million.
- Buyers might want to pay less to keep the mortgage under the cap.
- Buyers might put down more money so the entire mortgage interest can be deducted.
The thing is, once debt loses its status as a tax benefit, it’s no longer such a great deal.
Might homebuyers already be reacting to the new law? This morning, the NAR announced that existing home sales in November jumped 3.8% year-over-year “and reached their strongest pace in almost 11 years.” Perhaps some people are trying to lock in the deductibility of mortgage interest under the old rules.
The Blow to High-Tax States
The new law caps deductions for state and local income, sales, and property taxes at $10,000. This is not going to impact everyone. According to CoreLogic cited by The Journal, the median property tax bill is about $1,740. Only three counties have median property tax bills above $10,000 – all of them in the New York City area. But state income and sales taxes are also part of the package.
So in high-priced markets with high property, income, and sales taxes, this is going to put a damper on the enthusiasm about the tax benefits of owning a home.
The Home as an ATM gets costlier
The Home Equity Line of Credit (HELOC) has long been touted as a way to draw money out of the home with a loan whose interest, unlike credit card interest, is deductible. Under the new tax law, the interest on home-equity debt is no longer deductible, which raises costs and makes them less attractive.
In total, at least 23 million fewer households will be motivated to buy a new home under the new law, Zillow figures. Others have different estimates. Whatever the final numbers, one thing is sure: the tax incentives of homeownership have been radically slashed.
There are some caveats.
Property speculation is not impacted by these tax deductions. It’s impacted by a mixed bag of factors, such as provisions in the new tax law that favor real estate investors, by interest rates which the Fed is currently trying to nudge up, and by expectations of price increases, which can curdle.
Buying by foreign non-resident investors is also not impacted by the new tax law but responds to other factors, such as current efforts by the US Treasury Department to crack down on money laundering in real estate and by Chinese authorities to crack down on capital outflows.
But households that want to buy a home to live in will weigh the tax situation that they’re in, along with their other needs and wants. They will make compromises, as they always do. Tax benefits are not the only reason for buying a home.
Nevertheless, the new tax law represents a momentous change for how housing will be promoted in the future. The relentless wisdom that buying a home is the smart tax-thing to do will no longer apply for most households. The new law also reduces or eliminates the highly touted tax benefits of debt. Over the years, this will gradually shape how homeownership is being perceived. And I think the enormity of this change has not been fully appreciated just yet.
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