How the New Tax Bill Impacts U.S. Real Estate

Jan 18 2019

How the New Tax Bill Impacts U.S. Real Estate

While theoretical speculations of how the new tax bill impacts U.S. real estate are burgeoning, learning the real effect of the legislation could take many months of practice.

The $1.5 trillion tax bill passed in December 2017 is expected to impact the U.S. real estate market for years by:

  • considerably and permanently lowering corporate tax rate
  • reducing tax rates for people with higher standard deductions (in effect through 2025)
  • caping deductions of
    • local and state taxes, and
    • mortgage interest

While it is still difficult to put these changes into perspective, many real estate professionals are skeptical while the National Association of Realtors (NAR) fearing house prices might decline by as much as 10% across country.

Luxury Real Estate

Luxury real estate sales have already slowed down due to oversupply and limited demand, and new tax considerations decreased buyers’ confidence. Some real estate agents report that several of their client decided to postpone their home search until determining how much they will have to pay in taxes and plan accordingly.

The $10K cap on federal income tax deduction from real estate taxes is of primary concern (this amount used to be unlimited). This is a serious issue to buyers and investors in the luxury sector, and NYC, NY, NJ, CT and CA are particular zones of risk as annual real estate taxes there can easily reach $100,000. The WSJ says the change could result in New Yorkers paying up to $30 billion in extra taxes annually.

While it is not definite that the new tax laws will necessarily scale down the buying, potential buyers now become more likely to rent as a major advantage of homeownership is being significantly reduced. Furthermore, Moody’s predicts the $10K cap might make Manhattan real estate prices plummet.

At the same time, many property buyers in NYC are foreigners exempt from the U.S. tax law. Many brokers are already working with international customers who could be lured in if the prices do go down. But even if that does happen, it may take time before the market starts seeing any impact.

California, especially the San Francisco Bay Area, is another region where real estate tax deductions play a huge role. A $1.5 million house could incur $40,000 in total taxation. The $10K cap spells a $30,000 difference in tax deductions, which could result in $10,000 extra taxes for individuals in the 33% bracket.

Borrow Less, Stay Put: Mortgage & Capital Gains Impact

Even if we disregard the possibility of a drop in home values, lower mortgage deduction is essentially guaranteed to have an adverse effect on some homeowners. Individuals used to be able to deduct interest on up to the first $1 million borrowed, and now this figure is reduced to $750,000, which, nevertheless, is a positive change from the $500,000 cap proposed initially.

Example: 30-Year Mortgage

If you borrowed $1 million on a 30 year mortgage at 4.00%, your interest for the first 12 months is $39,680. For $750,000, the interest for the same period is $29,760. So, even if you end up in the 25% bracket the new legislation would cost about $2,500 in extra taxes.

Don’t Move: Capital Gains Implications

The lower deduction takes effect with new loans only, so those who have $750,000+ mortgages already get less incentive to move. But capital gains taxation becomes another reason to stay put. Homeowners selling their house could exclude up to $500,000 in capital gains if they’ve lived in the house for at least 24 out of the 60 months prior to the sale. Now to qualify for the same deduction one has to live in the house for at least 60 out of the last 96 months. This could lead to lack of supply in some markets, although that should counterbalance the feared decrease of home prices.

Second-Home Buyers: One Way or the Other?

An important piece of good news for second-home buyers is that mortgages on second homes count toward the mortgage deduction, even though they were excluded initially. This makes areas which do not have state taxes even more appealing to all real estate buyer, and especially to those of luxury properties. Although those properties are often bought with cash, making the mortgage deduction impact nonexistent.

How the New Tax Bill Impacts U.S. Real Estate: Personal Opinions

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