By now you have probably heard that the current tax plans being voted on by Congress have chosen to target homeowners that use interest and property taxes to reduce their tax bite as deductions that need to be reduced or go away entirely. Yesterday the House passed their plan and the Senate is soon to follow. It’s been a long time since we have had changes to tax law that so squarely affect Real Estate, but for many of us, make no mistake it will cost us thousands of dollars each year. And if you listen to the Real Estate Lobby, whatever version of the two laws is formally adopted (something that will almost certainly happen in the next few weeks), may cost some of us in the value of our home. I’ll touch on both here but to be sure, my views are neither Red nor Blue but Green. In other words, who is this going to hit financially, and I think it’s pretty clear California is at the top of that list. In fact, it’s been a long time since I’ve had so many of my great past clients call about one topic like they have about this. So, for this year end blog post I will attempt to answer the 3 questions that have been raised the most and in 2 weeks you will get a video interview from me on this topic. Of course, nothing is yet finalized but it’s pretty clear that despite a lot of uproar from California and a few other states change is going to happen and it’s going to cost some of us some money.
Let’s start with what is being likely to be enacted and the answer to the first question which is when will this start?
First, if the House bill is approved, you will only be allowed to deduct interest on up to $500,000 of loan. Meaning if you buy a home after 2018 and have a loan of more than $500,000 (and for a lot of people in our valley, it can be a lot more than that), you will no longer be able to deduct that interest. Next is even bigger -the property tax deduction. The House bill caps the amount of property taxes you can deduct to $10,000 and the Senate bill eliminates the property tax deduction completely. That is the far bigger issue for many people that have either no loan or a very small loan in which interest deduction may not cost them much. EVERYONE pays property taxes and for some, it’s a BIG number. Further, and a lot of people aren’t really talking about this, the new laws would require you to own a home for FIVE years, not the current two years, to avoid paying capital gains should the home go up in value. Want to further reduce the amount of homes coming up for sale and reduce the amount of Real Estate transactions? This part of the tax reform does this for sure. Also, for those fortunate enough to own second homes, no more interest deduction for you and if you have a home equity line, bye bye deduction. This will all start next year under the current plan. There are some other issues that will affect builders and low-income housing, but these are the ones that affect you and I.
Second, how much will this cost me? To be sure for many Americans, the answer is effectively zero. Over one third of our country doesn’t own a home. Another third owns but with no mortgage. The elimination of a Mortgage Interest Deduction means nothing to them. But the reduction or worse ELIMINATION of the property tax deduction is a different story. Everyone that owns a home pays property taxes and though they don’t all itemize, for people in expensive states like California, New York and Illinois it’s a major incentive to home ownership and losing it can cost a bunch. Before writing this, I went back over the last 2 years and counted how many homes I sold over $700,000. It was 180. Over 1 million was 39. Losing the property tax deduction alone will cost each of these families over $10,000 each year. Of the 39 homes I sold over 1 million, all but 4 had loans over $500,000 and many had loans over $900,000. Losing the mortgage interest deduction for many of them will cost thousands each year. The median price point in LA County is almost $560,000. In Orange County it is over $750,000. It’s safe to say that the higher in price point we go the bigger the financial hit and for some it could very easily mean over $7,000 year in real dollars lost to them. One client buying a home for $1,120,000 who is closing this year and has loan of $850,000 (closing this year means he keeps the current 1.1 million interest deduction limit) figures closing next year would cost him over $50,000 in real dollars in the 7 years he plans to own that home in mortgage interest alone. Make no mistake, this will mean a lot of financial benefit to homeowners in expensive areas like Santa Clarita will be lost.
Third, what will happen to the value of my home? This is really one that in the short term it’s hard to see it affecting the value of homes in Santa Clarita under $650,000. We still live in a market in which it’s expected we will have another year of appreciation in 2018 solely due to short supply and at least steady demand. Between $650,000 and 1 million will likely be affected somewhat, especially with move up buyers that will now lose at least some of the financial benefit of moving up and buying bigger. Consider this-the move up buyer that has a loan now of $700,000 can write off all that interest. If he stays, he keeps that deduction, its grandfathered in. If he moves up to a 1,200,000 home with a $900,000 loan he loses $400,000 in interest write off. The difference between the $500,000 he would still have but not the other $400,000 in loan amount he would until now write off. So, wont the move up price points be affected by taking away that financial incentive to buy bigger? Wouldn’t it make sense to assume so? That move up buyer will be more inclined to stay put or certainly buy less of a home. One thing I have noticed since the mortgage meltdown is buyers are more conservative than ever. They often buy less, sometimes a lot less home than they can afford. Further, they are well aware of exactly how much that new home will cost them and exactly what their write offs will mean to them based on their tax bracket. I make sure all buyers know these numbers as do all good lenders. Last, the over 1 million market will be affected and potentially quite a bit. It’s already the part of the market that has the lowest number of buyers in SCV, obviously. Now you either limit or take away entirely tens of thousands in financial incentive to buy those homes? How could it not? I deal with a fair amount of well off people and to be sure, for many they will invest in Real Estate and their own home will continue to be an important part of that. But this group is also very smart with money and now changes are being made that reduce the incentive to buy bigger. And the second home market? Look out in areas that rely on that. Finally, it could be argued that in time, the under $650,000 price point could also be affected. One of my favorite exercises with first time buyers is educating them how by writing off interest and property taxes they can often buy for less than what it costs to rent, or get a home for the same effective cost per month as an apartment. Based on what the final version of this reform looks like, that can change now too.
I realize that this is a difficult topic to analyze and predict what may happen. Many politicians are claiming that a lot of good will come from it. I always question what any politician says, but hopefully there will be positives that affect all income sectors. To be sure though it’s hard to see how it will help homeownership, stimulate home building, reduce costs to purchase or any other obvious economic drivers. If it negatively impacts property values, that won’t be seen as a positive by homeowners either. There is a lot more to this reform that will affect a number of other entities, specifically schools and nonprofits. I won’t comment on any of that. What I will say is that whatever the final signed legislation is will cost many Santa Clarita homeowners some real money.