After weeks of hard-fought battling and political maneuvering, the Senate passed a $1.5 trillion tax bill just before Christmas 2017 in what was called the “most drastic changes to US tax code in 30 years.” From individuals to corporations, across the country and across industries, the new tax laws will have a significant financial impact.
The real estate sector will be among those most impacted, both by the laws themselves and the impact on the market. The changes are a mixed bag. In its guide to what the Tax Cuts and Jobs Act means for homeowners and real estate pros, the National Association of REALTORS (NAR) said it was “concerned that the overall structure of the final bill diminishes the tax benefits of homeownership and will cause adverse impacts in some markets.” However, it also included successes and improvements, such as the exclusion for capital gains on the sale of a home.
Tax law is complicated and can be tough to parse, but all real estate professionals need to be prepared for how these changes could impact their business.
Changes in tax deductions means fewer buys
Under current tax laws, there is no limit on the amount of local and state taxes that can be deducted from federal income taxes. The new tax law changes that by putting a $10,000 cap on tax deductions. This could make a big difference for people who own homes in areas with high local property taxes, such as New York, New Jersey, and California, because it might discourage people from buying in those areas. Instead, the sales activity could shift to other regions or encourage people to buy cheaper property. The luxury residential real estate markets in those highly taxed areas could suffer as a result. This market is already facing sluggish growth, thanks to a combination of oversupply and a limited buyer pool, according to the 2018 National Housing Forecast by realtor.com.
Mortgage interest deductions are capped
In addition to capping local and state tax deductions, the new tax bill also caps the deductions for mortgage interest. The mortgage-interest deduction will now be capped at $750,000 for new mortgages. The NAR described this as “a direct threat” to homeowners because, among other things, it could increase taxes for millions of homeowners and lead to a 10 percent drop in home values. The cap does not apply to existing mortgages—only ones for new home purchases—which has the potential to discourage people from buying expensive property. It’s another way the luxury real estate market could be negatively impacted.
Commercial real estate wins
While the residential real estate market may suffer from the new tax structure, some experts believe the commercial real estate business will benefit from the changes. The Tax Cuts and Jobs Act provides deep tax cuts for corporations and more deductions for businesses that are structured as LLCs or partnerships. Many real estate businesses are set up in this format, or as other types of “pass-through” companies, which means those businesses that are invested in commercial real estate may now be able to pay the same tax rate as their personal income tax rate. This will ultimately result in much lower annual tax bills than before.
Forecast remains uncertain
Cause-and-effect relationships are never set in stone when it comes to taxation, which is why there remains such fervent disagreement about “what works” or what impact something like corporate tax cuts have on the economy. The fact is there are many variables that still need to be played out and explored. For example, the new law allows more people, and especially the middle class, to keep more of their money, which could result in more real estate purchasing as budgets become less tight.
Another consideration is the effect the law will have on stock markets and interest rates. The true results are yet to be seen, but if there is anything certain about the new tax law, it’s that the law of unintended consequences will win out in the end.
About the Author: Matt Murphy is CMO of Chime Technologies.