House and Senate Republicans have rolled out separate versions of tax-reform plans, aiming to cut taxes for corporations and individuals. Although the two bills diverge in a number of ways and the fate of both remains in flux, one thing’s for certain: Homeowners would be affected under both plans.
In this article, we lay out the changes to housing-related provisions under both plans and explain what they would mean for existing homeowners and first-time homebuyers.
Where are we?
The House version of the tax bill passed by a 227-205 chamber vote ahead of Thanksgiving. The Senate Committee on Finance approved the Senate’s version of the Tax Cuts and Jobs Act late on Nov. 16 with a 14-12 vote along party lines.
The Senate’s bill is to go to the full Senate for a vote the week following the Thanksgiving holiday. President Trump has called on lawmakers to pass one cohesive bill by Christmas, and Republican legislators would like to see the reforms take effect in 2018.
What are the changes?
Here’s a quick overview of housing-related changes proposed in the bills:
- Both bills nearly double the standard deduction, while eliminating personal exemptions.
- The House and Senate both proposed changing residency requirements for capital gains home-sale exclusions by increasing the live-in time period to five out of the last eight years. Current law allows people to write off up to $250,000 — or $500,000 for couples filing jointly — from capital gains when selling a home, as long as they have lived in it for two out of the past five years.
- Under the House plan, mortgage borrowers can deduct mortgage interest on loans up to $500,000, for debt incurred after Nov. 2, 2017. Currently, the tax deduction cap is $1 million. The deduction for state and local income taxes would be gone. The state and local property tax deduction would remain but be capped at $10,000. (There is no cap, currently.)
- The Senate bill would leave the mortgage interest deduction unchanged, but eliminate all state and local tax deductions (SALT), including deductions for property taxes.
Read more about the Senate and House bills here.
Fewer people will claim mortgage interest deductions
The National Association of Realtors (NAR), a vocal critic of the tax reform proposals, expressed through statements and press briefings that both plans would negatively affect homeownership. The association has called the tax reform legislation an “overall assault on housing.”
“Simply preserving the mortgage interest deduction in name only isn’t enough to protect homeownership,” NAR President Elizabeth Mendenhall said in a statement.
Nearly doubling the standard deductions and repealing some itemized deductions would likely mean that far fewer people would itemize when they file taxes. NAR officials worry that these moves will undercut the incentives to pursue homeownership.
The standard deduction is a fixed dollar amount, based on your filing status and age, by which the IRS lets you reduce your taxable income. The itemized deduction allows you to list your various deductions, including the mortgage interest deduction. You can claim one or the other — whichever lowers your taxable income more.
The standard deduction for a married couple filing jointly is $24,400 under the House plan and $24,000 under the Senate plan. Wolters Kluwer, a global information services company, suggested in an analysis that only those taxpayers who would deduct more taxes through itemizing than taking the bigger standard deduction — the top earners — would benefit from itemizing deductions like the one for mortgage interest.
Impact under House plan
Capping the mortgage interest deduction
The good news is that the majority of existing homeowners won’t be affected by the cap on the mortgage interest deduction, because only about 21 percent of American households take the deduction under the current law, according to the Tax Policy Center.
But about 18.5 percent of new homebuyers would get hit with a bigger tax bill on their housing-related tax liabilities, according to an analysis released by Trulia, an online real estate resource for homebuyers and renters.
Many economists say the mortgage interest deduction distorts the housing market by driving up home prices and soaking up much-needed supply, and that it doesn’t necessarily help increase homeownership rate.“Because the mortgage interest deduction skews to upper-income families, it encourages people to buy bigger homes,” Nela Richardson, chief economist at Redfin, a Seattle-based real estate and technology company, told MagnifyMoney. “It also encourages builders to also build bigger homes, so it encourages sprawl.”
Less than 10 percent of the bottom 90 percent of the income distribution receive the tax subsidy on mortgages, the Tax Policy Center said.
Richardson added that this doesn’t mean the deduction should be completely eliminated. She said she thinks putting a cap on the deduction is only to make the math work for the corporate tax cut, though it is not structured in a way to help middle-class homeowners.
“People who have the means to buy those homes” with a mortgage of more than $500,000 “would continue to buy those homes,” Richardson said. “What we’d like to see is [changes] to help buyers who wouldn’t be able to afford a house unless they got some kind of tax credit. That would be a subsidy that was progressive instead of regressive.”
A silver lining to some: Middle-class homeowners might benefit from an income tax cut, which hopefully would help them purchase a house, experts say.
“The result of that is still a little fuzzy,” Richardson said. “It’s not clear that middle-class buyers in the long run would actually receive an income tax cut.”
What does it mean to first-time homebuyers in expensive cities?
The mortgage interest deduction provides little benefit to new home buyers because many new U.S. homeowners do not itemize or are in the 15 percent tax bracket or lower, William G. Gale, chairman of federal economic policy in the Economic Studies Program at the Brookings Institution, wrote in an analysisfor the Tax Policy Center.First-time buyers are generally looking for cheaper homes. Nationally, the median sales price for existing homes is $245,100, according to the Federal Reserve Bank of St. Louis, well under the $500,000 cap, so capping the mortgage interest deduction shouldn’t affect them too much.
But for buyers in high-cost markets, where demand is high and affordability is challenging, the cap will sting, Richardson said.
“You cannot find a $500,000 home in the Bay Area,” Richardson said. “Good luck with that.”
In San Francisco, the median home sales price is around $1.2 million, according to Redfin and Trulia.
Home prices are expected to go up next year, as the Federal Reserve is expected to increase the short-term interest rate by year’s end, economists say.
“For the first-time buyer, you are dealing with this double whammy,” Richardson said. “If you add onto the fact that really expensive states’ first-time home buyers won’t be able to deduct all of the mortgage interest, then that is an additional expense. So it really is a challenging situation to put new buyers in.”
Trulia reported that across the 100 largest markets, more than half of homebuyers in coastal California, New York and Cambridge, Mass., would experience an increase in their home-related tax liabilities if they purchased a home under the House plan.
Impact on housing supply
Real estate experts expect less movement in the housing market since people who already own homes with big mortgages can continue to deduct the interest. This would make the housing supply crunch even worse in those expensive markets because people may choose to stay in the same house, knowing they couldn’t deduct the same amount of interest on their next big mortgage.
Factor in a longer live-in requirement for capital gains exclusions of homes sales, which economists believe will result in more homeowners waiting longer before moving to a different house to save on capital gains, and it would be even trickier for first-home buyers to bid for a desirable house in higher-end markets.
“It’s definitely not going to help alleviate price increases,” Cheryl Young, senior economist at Trulia, told MagnifyMoney. “But it will also contribute to competition.”
Trulia found that roughly 10 percent or more of existing homeowners in California and the Northeast would lose the incentive to sell their homes. Nationwide, the figure is 2.5 percent.
What does it mean for homeowners in high-tax states?
People living in high-tax states, such as New Jersey, New York and California, where homes are also costly, will see a rise in their property tax liability on taxes paid above the $10,000 property-deduction cap.
Trulia estimates that more than 20 percent of existing homeowners in New York and San Francisco would experience an increase in their property tax bills. Nationally, about 9.2 percent of existing homeowners will experience an increase in their property taxes.
Impact under Senate plan
Bigger property tax liability
Although the Senate plan is in some respects seen as more straightforward than the House bill, removing all SALT deductions would have a more expansive impact on homeowners across the country. That’s because they wouldn’t be able to deduct their property taxes anymore, Trulia’s chief economist, Ralph McLaughlin, explained in an analysis.
Existing homeowners in the Northeast and the Bay Area — New Jersey, New York, Connecticut and California — would be hit the hardest, according to McLaughlin.
A study commissioned by the National Association of Realtors and conducted by PricewaterhouseCoopers (PwC) found that, for many homeowners who currently benefit from the mortgage interest deduction, the elimination of other itemized deductions and personal exemptions would cause their taxes to rise, even if they elected to take the increased standard deduction.
The study found that homeowners with adjusted gross incomes between $50,000 and $200,000 would see their taxes rise by an average of $815.
Mortgage interest deduction would be worth less
Leonard Burman, a fellow at the Urban Institute and professor of public administration and international affairs at Syracuse University, wrote in an analysis that if homeowners cannot deduct state and local income, sales and property taxes, only the very wealthy and the very generous would benefit from itemizing. As a result, he estimated that only 4.5 percent of households would itemize under the plan, compared with the current 26.6 percent.
“Even for those who continue to itemize, the mortgage interest deduction may be worth much less than many homeowners believe,” Burman wrote. “This is because net tax savings depend not only on whether mortgage interest plus other deductions exceed the standard deduction, but by how much.”