Reader question: Should proposed tax reform affect my homeownership plans?
Several new tax reform plans are now being debated in Washington. If passed, how will they impact real estate ownership?
These are different and competing paths to tax reform. No less important, a flood of changes and the need to reconcile any differences between the two bills could alter the final rules.
Every lobbyist in Washington is on the case, arguing that its special interest needs to be protected if not enlarged.
These are Republican-led plans. As of this moment, no Democrat has signed on. The result is that even a few Republican defectors could sink the proposals.
Lastly, it’s entirely possible that no reform legislation will be sent to President Trump. The divide on many issues is so substantial that a unified bill might never pass.
Following are potential changes that could affect your results in buying a owning real estate.
The mortgage interest deduction
The mortgage interest deduction, or MID, is a substantial tax break you get when writing off interest you pay on your mortgage.
The Senate plan doesn’t touch the issue. However, the House would reduce the maximum write-off to the interest on a $500,000 mortgage, down from the current $1 million. Such a reduction would largely impact selected homeowners in high-cost areas such as New York, California, Washington, DC, and Hawaii.
The median home price for existing homes in the U.S. was just $245,100 in September according to the National Association of Realtors. So House bill would hit only those with relatively high mortgage balances.
Will the mortgage insurance deduction disappear?
Mortgage insurance premiums are now tax deductible. This deduction is usually created on Capitol Hill through the use of “extenders,” or an extension of current law, at the end of the year.
The term “mortgage insurance” is not mentioned in either proposal which means unless there is an extender in 2017, the mortgage insurance deduction will simply disappear.
The property tax deduction and SALT
Now entirely deductible, property tax write-offs would be limited to $10,000 under the House plan and eliminated under the Senate proposal.
How could this affect your bottom line? Let’s say you’re in the 25% tax bracket for income and you pay $300 per month in property taxes.
Your total write off is $3,600 per year. The House plan wouldn’t affect you. The Senate proposal would increase your tax bill by $900 per year.
Then there are State and Local Taxes (SALT). Current tax law allows you to write off income tax or sales tax from your home state. Eliminated under both proposals, tax filers will be taxed on the tax money they pay to state and local governments. In effect, a tax on a tax.
It would affect you most if you purchase a big-ticket item during the year and live in a high sales tax state. A typical car, for instance, can cost you $3,000 in sales tax, which you would no longer be able to write off.
Likewise, residents of states with high income taxes like California, Oregon, and Minnesota would also take a hit.
The current standard deduction — the amount that you can write off without tallying up individual deductions — would double.
The deduction would rise from $6,300 to $12,600 for individuals and from $12,000 to $24,000 for a married couple.
Because the standard deduction would become so large, most taxpayers will not deduct ANY mortgage interest. They would pay less taxes by taking the lump-sum deduction instead of adding up all their write-offs.
Right now, 21 percent of all returns write off mortgage interest. The Tax Policy Center estimates that — if tax reform goes through — only 4 percent of all returns will include the deduction.
The same logic applies to property taxes. Even if property taxes can be written off it is unlikely that most filers will take the deduction. They will, instead, take the standard deduction. The result will be no effective tax difference between renting and owning for millions of homeowners.
In theory, the massive tax advantages of owning are tipping the scales for renters to get out there and buy. Tax reform, then, could work to cool the housing market. While this is good news for prospective buyers with sticker shock, it’s could mean slower future gains for homeowners.
The ability to write off interest on second homes would end. This would significantly impact all states with vacation and recreation areas.
Vacation residence sales have been strong of late, but tax reform could slow demand.
The home equity line of credit (HELOC) deduction
The ability to write off the interest on as much as $100,000 in home equity financing would be eliminated. This would impact all states as well as the ability of property owners to raise funds for such costs as business start-up expenses and college tuition.
This would increase taxes by $1,250 per year, assuming a $100,000 HELOC at 5% interest for someone in a 25% tax bracket.
Capital gains on home sales
Under current rules, a married couple can shelter as much as $500,000 in profits when they sell a home ($250,000 if single) provided they have used the property for two of the past five years.
Tax reform would say that you have to use the property for five of the past eight years. Given the frequency with which people move, some owners would lose the exclusion altogether.
Moving and accounting expenses
The ability to write off moving expenses would end. Likewise, you won’t be able to write off any personal tax preparation bills. Seemingly small changes, but new homeowners are often on a tight budget. Every possible deduction would help.
The bottom line
If tax reform passes homeowners and potential homeowners will find that many of the tax benefits now associated with ownership are reduced or eliminated.
So far, housing groups aren’t fans.
“The direct result of these changes,” said the National Association of Realtors in a letter to Congress, “would be a plunge in home values across America in excess of 10 percent, and likely more in higher cost areas.”
For details and specific impact on your personal situation, be sure to speak with a tax professional (as we are not tax advisors), should any new tax legislation pass in Washington.