The reduction of the mortgage interest for new buyers only, a lengthened time frame on capital gains, a $10,000 cap on deductibility of property taxes and the elimination of moving expenses deduction — this bill is bad for real estate.
President Trump and the Republican congressional leadership have proposed a new tax bill. The bill consolidates some income tax rates, lowers the corporate tax rate, reduces the tax rate for certain pass-through businesses, eliminates the estate tax and takes away many long-established deductions and exemptions.
Sounds great, right?
Well, it’s terrible for housing. Really terrible. This bill is really bad for you, the consumer, and you should be doing everything you can to fight it.
It’s almost a joke, a pastiche of anti-housing policies, a ghastly tapestry stitching together a patchwork of terrible ideas that are going to severely depress real estate markets across the country at a time when homeownership is already at a historic low of 63.9 percent.
Why? Well, it’s bad enough that the tax bill will negatively impact property values by reducing the mortgage interest deduction, changing the capital gains extension on residences, capping property tax deductibility and some other terrible stuff. That’s bad for homesellers, homebuyers, homeowners — and realtors — because what’s bad for all of them is usually bad for us.
But even worse than that, the new bill actually makes it more expensive to move! And that’s not good. We want people to move. We make our living when people move.
So we need greater motility, not less. Indeed, most of the markets in this country need inventory because homeowners with historically low interest rates already have a lot of incentives to stay put and hold onto those rates.
But this bill is going to hurt housing in a lot of ways…
The bill reduces the value of the mortgage interest deduction — but for new buyers only!
The tax bill lowers the mortgage interest deduction cap from $1 million to $500,000, which will particularly impact people in high-priced markets (and luxury buyers elsewhere in the country). Owning a high-priced home is going to be a lot more expensive under the new law.
Now, I get that the mortgage interest deduction is not the most economically efficient housing tax policy. It’s regressive, helping only wealthier taxpayers because most lower-income homeowners take the standard deduction rather than itemize.
It doesn’t necessarily incentivize homebuying, it just encourages people to buy larger houses. I know all that. So if Congress wanted to get rid of the mortgage interest deduction entirely, I wouldn’t love it, but I could live with it.
But the new bill does something really, really stupid — it puts the $500,000 cap on new buyers, but keeps the $1 million cap for existing homeowners. On its face, it’s an attempt to be fair, to help current homeowners preserve a tax break they depended on when they bought their home.
Think, though, about what that does for motility — the rate at which people move. If I own a home with a mortgage between $500,000 and $1 million, I can now deduct all my mortgage interest.
But if I sell my home and buy something else that’s the same price, or more expensive, I’m not going to be able to deduct as much of my interest as I do today.
So why move? I’ve probably got a great rate. I can deduct maybe all of my mortgage interest. And most of my payments for the next 10 years or so are interest payments.
So I stay put. And that person who would have bought my house stays put. And the person whose house I would have bought stays put. And the agents we would have all hired? They don’t make any money.
In other words: bad for sellers, bad for new buyers, and bad for agents and brokers.
The bill requires people to say in their homes longer to get the capital gains exemption…
Tax law has long helped homeowners and facilitated motility, by allowing them to exempt the capital gains on their primary residence. If you’ve lived in your primary residence for two of the past five years, you can exempt up to $250,000 of your capital gains ($500,000 for married couples filing jointly).
So what does the new tax bill do? It makes you stay in your home longer — you have to own and live in the home for five out of the last eight years. On top of that, you might not even get the exemption if you make too much money.
Now, I get that most people aren’t lucky enough to generate more than $250,000 of capital gains by living in a home for just two years. So I’m not sure how many people this will affect.
But that’s sort of the point. How much money could we be saving by requiring someone to live in a home for three extra years in order to claim the exemption? Why should it matter? And if it’s a small amount, why put that disincentive to moving in place?
The bill makes homes with high property taxes much less attractive.
Currently, the federal government allows you to deduct your state and local taxes and your property taxes from your federal tax bill. That makes sense, insofar as it feels unfair to tax you on money you already used to pay your state and local taxes.
But that’s changing with this new tax reform, which eliminates the deduction for state income taxes — and puts a $10,000 cap on deductibility of property taxes.
Now, for some people, this might not be a big deal. Depending on where you live, you might be thinking, “well, that should be enough, what kind of idiot would buy a house with more than $10,000 in property taxes?”
Maybe you’ll discount this because you live in a low-tax state, and you won’t be impacted. But for a lot of people, this change makes it much more expensive to own your own home. And that’s not good for housing generally.
The bill eliminates the deduction for moving expenses…
OK, this is a small thing, but it’s just adding insult to injury — the bill eliminates the deduction for moving expenses.
Right now, you can deduct expenses if you’re moving for a new job or a transfer for your existing job. This may not seem like a big deal, but when your move costs you upward of $10,000, that might mean a deduction worth $3,000 or $4,000.
No, it’s not going to make the difference between someone moving and not moving, particularly if you get transferred or take a new job.
I don’t think many people are going to decide to stay put because they can’t deduct their expenses anymore. But it’s just another example of how this new bill depresses the incentive to get a new home.
The bill makes second- and vacation-homes much more expensive…
If you work in a second-home market, realize that this bill just reduced the value of every home in your market.
Why? Well, figure that anyone buying a second home is probably in the 39 percent tax bracket (otherwise, they most likely can’t afford a vacation home).
So let’s say they are buying that $1 million beachfront home, getting an $800,000 mortgage.
At today’s rates, they’ll pay about $5,000/month as a mortgage payment, most of which (at least for the first few years) will be interest. Thus, if they pay $60,000/year in interest, they get a deduction of about $24,000, which means their effective payment is $36,000/year.
Now, under the new law, they can’t deduct that interest. So maybe they can no longer afford $60,000 a year in second-home payments. If they can only afford that effective $36,000/year that they were paying under current law, their buying power just got slashed by about 40 percent.
Maybe they’re rich enough, or they’re getting a tax break in this bill in some other way that allows them to buy that same $1 million home even without the tax deduction. So maybe you won’t see a big hit in your second-home prices. But maybe you will.
Don’t own, invest!
Here’s what’s also kind of strange — on top of all these disincentives to buy or sell a home, the tax bill simultaneously creates or preserves a number of advantages for owning investment property. In other words, the tax bill is bad for homeowners, but not for real estate investors. Odd, right?
Here’s what I mean…
First, real estate investors can still deduct the interest on their loans and property taxes without any cap. Homeowners can only deduct their mortgage interest up to $500,000, and property taxes up to $10,000, but there’s no cap for investors.
That’s because investment property deductions for interest or taxes are not itemized deductions. Rather, they’re deductions in computing net rental income.
Indeed, the tax bill specifically exempts real estate investors from a new 30 percent limit on business interest deductibility, so it’s especially favoring them compared to other business owners.
Second, the preserves many other tax advantages for investment real estate: the deductibility of maintenance costs and depreciation, the like-kind exchanges and so on.
Third, one of the major tax changes in the bill — conferring a 25 percent tax rate on so-called “pass-through businesses” — could reduce the tax rate for passive real estate investors who buy and manage buildings through LLCs or partnerships, which is almost all of them.
Now, I have no problem with maintaining or improving the tax advantages for investment real estate. That’s great. I just don’t get why the new law should be so bad for the residential real estate market and at the same time be so good for the investment real estate market.
The new tax bill is only bad if you’re a…
Seller: You might not be able to exempt your capital gains when you sell.
Buyer: You might not be able to deduct your mortgage interest on your new home or your moving expenses.
Homeowner: You might not be able to deduct all your property taxes.
Second homeowner: You can no longer deduct your mortgage interest.
Agents: Homebuyers are losing incentives to buy a home, and homeowners have lots of incentives to stay put to keep their full mortgage interest tax deduction and to wait out the exemption for their capital gains.
I dunno, that seems like a lot of people.
Finally, you might say, “well, this might be bad for me personally, but I’m a patriot, so if it’s good for the country I’m for it!” OK, I get it. I agree. I’d be willing to make sacrifices if I felt that they went to the common good.
But why are we the only ones who have to be patriots? And why are we making sacrifices for all these other people, who seem to be doing pretty OK right now…
Corporations, which get a huge tax cut from 35 percent to 20 percent, and can repatriate their offshore profits at a major discount.
Hedge fund owners, who get to keep their carried interest loophole, and pay capital gains rates on what is really ordinary income.
Business owners who might get to pay a 25 percent rate on their income, rather than the rates paid by their employees…
Heirs of really, really rich people who get the elimination of the estate tax and still get the stepped up basis for capital gains on all their property and equities (which, by the way, is nuts).
Yes, you could argue that, depending on their personal situation, certain middle-income taxpayers might get a small tax cut, maybe a few hundred dollars.
But on balance, they’re not going to come out ahead if they’re homeowners, or buying a home, or selling a home, or working in the real estate industry.
When it comes to my day job, I only care about the facts and how they impact my industry, my business, my workforce and my clients.
And the facts are, this is not a good tax bill for real estate and housing.