First of all, let me preface this post by clearly stating that I am not an CPA or otherwise qualified to give tax advice, so please view this simply as my attempt to point out some aspects of the new tax law that may impact homeowners, buyers and sellers, so that you can bring up the relevant questions to your accountant. Also, this is not a comprehensive analysis — I am just giving an overview of key elements. So…
Let’s talk taxes. Fun. Ha! Nobody likes them, we all have to pay them, and most of us are still trying to figure out how the new tax law will impact our bottom lines. Considering one of the supposed goals of tax reform was that people be able to do their returns on a postcard, I’d say that Congress failed. Even accountants are still trying to make sense of various provisions and loopholes as they struggle to answer their clients’ questions.
I guess we won’t know for sure until next year, when we actually file our 2018 taxes, but there are a few aspects of the law with implications for homeowners that seem pretty clear — most of these have been well-covered by the press, but I thought it was still worth summing up here, with a local real estate angle. After I’ve highlighted the changes, I’ll give my two cents on whether the new tax law will impact the real estate market here in Cambridge, Somerville and the Greater Boston area generally. So here we go!
Mortgage interest deduction retained but lowered / HELOC interest deduction limited
As most folks know, a nice bonus to owning a home is that the mortgage interest (which in the early years of a loan, is most of your monthly payment), has been tax deductible on up to $1M of debt. The House bill would have reduced that cap to $500k, but in the end, what passed is a cap in the middle of $750k. If you have a second home, it still qualifies for that deduction, but keep in mind that it’s not $750,000 per mortgage — that cap applies to the combined total debt on your first and second homes (this was also the case when cap was $1M). Note that if you already own your home(s), you are grandfathered in with the previous $1M cap, so all of this only applies to homes purchased after December 14 last year.
Another change to deductible interest has to do with HELOC loans, where homeowners use the equity in their home to get low-interest loans. That interest used to be deductible on debt of up to $100k (if married filing jointly) regardless of what the loan was for (new car, college tuition, etc.) But now that interest is only deductible if the loan is used for home renovations. And I believe that even existing debt will be subject to the new rules and no longer deductible. (There’s a ton of contradictory information out there, so please ask your accountant.)
State & local tax deduction (for income & property) capped at $10,000
This one will sting for many of us in Massachusetts. Basically, where we used to be able to deduct all of our state income taxes and all of our local property taxes, the new law puts a $10,000 cap on THE TOTAL of these two deductions (same cap for singles and married couples). So let’s say you and your spouse pay a combined state income tax of $15,000 and your property taxes are $10,000. Formerly, you’d get a $25,000 deduction, but now you can only deduct $10,000. This is bad, but it could have been worse — early bills by the House and Senate would have totally wiped out any deductions for state and local income taxes.
Capital gains exemption for selling primary residence retained in its current form
Hallelujah, you can still exclude capital gains of up to $250,000 for singles or $500,000 for married filers from profit on the sale of your home, as long as you’ve lived there at least two of the last five years. Earlier House and Senate bills proposed changing the time you had to be in the home to five out of eight years or wiping the exemption out completely. Consider this a win.
Additional changes impacting rental properties
I don’t want to get too bogged down in the weeds on this one, mostly because this is where the law goes into a lot of specifics and loopholes and I definitely don’t claim to fully understand it. However, it’s important to note that any of you who own an investment property MAY have some additional tax benefits coming your way.
First and foremost, the new law does NOT repeal the 1031 Exchange of Like-Kind properties for real estate (allowing you to sell one rental property without paying capital gains tax if you roll the proceeds into another rental property) — this is not a new benefit, but the fact that it was retained is a coup, because it was removed for other like-kind exchanges.
You also dodged a bullet in the form of a provision in an early House bill that would have required you to pay 15.3% self-employment taxes on rental income. The House later decided this was “a mistake” and it was taken out of the final bill. Phew!
Other things to ask your accountant about if you own one or more rental properties:
Can you take the new 20% deduction on pass-through income for your rental income?
Will you benefit from bonus depreciation for any improvements you make to your property?
What does this all mean for the local real estate market?
Interestingly, though the National Association of Realtors has been freaking out about all these changes (and btw, lobbied Congress hard and had some big successes changing earlier versions of the tax bill), I’ve only had a couple clients who’ve even raised the issue. But let’s look at why there is concern when there is…
First off, one of the biggest fears of the real estate industry is that the combined impact of a higher standard deduction with decreased incentive for homeowners to itemize their taxes in many cases reduces the tax incentive for buying a home as opposed to renting. Congressional estimates predict that 90% of taxpayers will fall into the category where being a homeowner has no advantage over being a renter. So will these people just forgo buying homes and stay in their apartments forever? Doubtful.
While losing some of the tax benefit of homeownership is definitely a bummer for those of us who already own homes and are used to getting these deductions, I really don’t believe this will stop new buyers from entering the market. I say this because the buyers I work with are generally not buying a home for the tax break. They are buying a home to OWN A HOME, put down roots, have freedom to do renovations and/or get a pet, for a feeling of security, consistency/predictability of expenses, and to build equity and appreciation over time. These are all great reasons to buy a home and they are not going away.
Another concern that the industry has is that the lower $750,000 cap on mortgage interest deductions may dis-incentivize people from selling their current homes, especially if they are currently grandfathered into the $1M deduction on their current home and/or were planning to trade up for a home where the new mortgage would exceed $750,000. Now this I can see being a realistic concern, and fewer listings coming on the market, on top of our already serious inventory shortage, would be very bad indeed. But again, this assumes that people are making their homebuying decisions based on the tax implications. In my experience, this is not the case. And if there IS any change in attitude, it would only be with the very specific segment of the population whose future mortgage would fall between the new $750,000 cap and the prior $1M cap.
And getting back to motivation, in my experience, sellers generally list their homes because their lives are changing and their current home no longer meets their needs — they may be growing their family and need more space or want a different school system, or their kids have all gone off to college and they want to downsize and/or move from a high-maintenance single family into a “lock up and go” condo, or they’re changing jobs and relocating out of the area. I don’t think a bit of a tax hit on their next home is going to stop them from making the changes their life demands.
So for what it’s worth, I don’t think the new tax law will have any negative impact at all on the Cambridge, Somerville or Boston markets. If anything, I think it could drive more buyers here, as our relatively low property taxes (in Cambridge’s case, among the lowest in the state), may have that much more appeal. Will be interesting to see.
And I’ll end with a reminder that I am a realtor, not an accountant, and my intention here was to give you something to think about — please consult your tax professional for actual tax advice 🙂