The proposed new tax plan is a homeownership killer by lowering the home mortgage interest deduction from the current $1 million to $500,000. The impact to new purchasers is effectively reducing their after tax income. Under the proposed bill, homeowners could only deduct interest on the first $500,000 of the loan, leaving them without a tax deduction for the remaining interest payments. Overall, it adds to the cost of homeownership.
Immediately, the proposed tax would have a multi-pronged effect on all of the hottest residential real estate markets. A $500,000 house might sound like luxury to those outside of the big metro areas but that’s become the cost of a standard or slightly above standard home in the biggest markets such as Manhattan where the average price exceeds $1 million, San Francisco at $820,000 inside the city, and San Jose averages about $575,000. With home prices rising rapidly, other cities will soon be above the $500,000 maximum the new tax bill allows. These include places like San Diego averaging $477,800, Oakland at $449,800, and Washington D.C. with average home prices at approximately $443,000.
Considering the difficulty the U.S. Congress has getting anything done, a new tax plan should be looking well into the future. If the intent, over time, is stripping the average American of homeownership tax benefits, the proposed plan will accomplish exactly that. As of late August, 19 cities saw a median home price increase of more than 14% in the last year and an average increase of nearly 30% over the last two years.
The 429-page GOP tax plan, called the "Tax Cuts and Jobs Act" is being billed as a boon for hard-working middle class Americans. However, just as the Millennial generation is finally moving heavily towards homeownership, they are facing diminishing tax incentives. And what a damper this is to younger generations just now starting to save a down payment for an extraordinarily expensive “average home”.
Fortunately, the fallout for retiring baby boomers won’t be as severe for those able to sell expensive metro homes to move to less expensive sunny suburbs. Or if they stay in an existing home mortgaged above the $500,000 threshold because the bill only applies to new home purchases.
As bad as this will be for homebuyers, it will also put a damper on some housing markets. Houses that can be mortgaged for below the $500,000 threshold will be in high demand but the demand for those above it will find few interested buyers. Sellers on the cusp will be pressured to keep the price lower. Buyers on the cusp will be faced with applying more discretionary income to down payments to lower the mortgage or paying a higher tax bill. This will have a smaller effect for those buying up to larger and more expensive homes. For many, the equity from selling an existing home will generate an adequate down payment to keep the new mortgage below the limit. However, those carrying a second mortgage on the first home could face a higher taxable income when buying up.
There are other negative ramifications for homeowners. One is a change in the ability to exclude up to $500,000 in capital gains from their gross income. Current tax law only requires the home to be your primary residence for 2 out of the past 5 years. Under the proposal, it has to be your primary residence 5 of the past 8 years to qualify. You’d only be able to use the write off every 5 years. It also places a $10,000 cap on deductions for mortgage interest for state and local property taxes.
House Ways and Means Committee Chair Kevin Brady, the author of the tax bill, said the House should pass the plan by Thanksgiving. But Congress’s history of not accomplishing anything may well turn this into a moot delayed Halloween Trick.
What are your thoughts about the proposed tax reform? Please comment below.
Author bio: Brian Kline has been investing in real estate for more than 35 years and writing about real estate investing for 10 years. He also draws upon 30 plus years of business experience including 12 years as a manager at Boeing Aircraft Company. Brian currently lives at Lake Cushman, Washington. A vacation destination, a few short miles from a national forest. With the Pacific Ocean a couple of miles in the opposite direction.