Tax reform has been on everyone’s mind of late, and the political noise and rhetoric has stirred up uncertainty in residential real estate markets, creating tension and highlighting hesitancy. President Trump is expected to sign the bill before Christmas week, so he can be applauded for a significant piece of legislation during his first year in office. Taxpaying homeowners and residential real estate professionals will not be applauding the effort.  

 

Here’s what the new plan holds for property stakeholders as of this writing:

  • The mortgage interest deduction is capped at $750,000 of debt—a compromise move from the current allowable $1,000,000 and the House’s proposed $500,000.
  • Up to $10,000 in total can be deducted from a combination of state and local income taxes and property and sales taxes; these taxes for 2018 may not be prepaid this month as had been thought earlier.
  • Borrowers with mortgages dated before December 15, 2017 may continue to deduct interest for loans up to $1,000,000.
  • Interest on home equity loans and second home mortgages are not deductible.
  • Moving expenses are not deductible.
  • Couples filing joint returns may continue to exclude up to $500,000 in capital gains on the sale of a home if it has been a primary residence for two of the last five years; individuals may exclude up to $250,000 in profit.
  • Alternative Minimum Tax calculations will continue through 2025. Although there are no specific income thresholds for A.M.T. taxpayers, typically their annual incomes range from $200-500K, and they do not itemize any deductions.

 

Since 1913 when Woodrow Wilson was President, homeowners have relied on financial incentives to purchase homes. Owning a home and the requisite mortgage have become part of the fabric of the American Dream and probably the most conventional way to build wealth and simultaneously strengthen community. Reducing previously expected deductions changes the math for would-be home buyers. Millennials who have become the newest group of purchasers are likely to retreat to the sidelines and remain renters longer.  When every dollar counts, fewer will be able to afford down payments and monthly carrying costs, so demand will shrink particularly in entry level and middle markets. Will values slip as a result especially in the suburbs of highly taxed states like New York, California and New Jersey?

 

“Owning a home and the requisite mortgage have become part of the fabric of the American Dream and probably the most conventional way to build wealth and simultaneously strengthen community.”

How will inventory be affected? Homeowners with prior loans won’t be in a rush to relinquish their deductible mortgages, so inventory will thin even more, and transaction volume will decline. If the drop in demand matches a proportionate drop in supply, prices will stay level. I don’t anticipate an exodus of NYC homeowners to less taxed cities, though some undoubtedly who do not earn their livelihood in the city may consider establishing residency in Florida or another less taxed state.

 

I take issue with economists who argue that these long held real estate tax advantages have in effect subsidized home ownership and encouraged excessive borrowing. On the contrary, I’ve seen far less discretionary moving in recent years. Ever since the financial crisis, buyers have become more conservative and more risk averse, and their appetites for leveraging have grown smaller.

 

There’s a bit of déjà vu this December as we move from one year to the next. Uncertainty defined the mood of 2016’s last real estate quarter following Brexit and the U.S. presidential election leading up to the inauguration. We began 2017 tentatively amidst a slowing real estate market, picked up some steam by mid year but seem to have circled back at year end to where we began.

 

On the other hand, the equity markets tell quite another story. To say it’s been a banner year for Wall Street and corporate America is an understatement as the Dow hit five, one thousand-point milestones in 2017, beginning the year just above 19,000 and closing at 24,754.75 yesterday. Soaring corporate earnings, especially at financial institutions, are expected to translate into $26-27B in bonus money according to one banker in the know.

 

Titled “The Tax Cuts and Jobs Act,” the new bill slashes the tax exposure for corporations from 35% to 21% and trumpets that the tax overhaul will lead to job creation and increased wages. Undoubtedly more pass through businesses will be created as tax attorneys, accountants and estate planners strategize with their clients about the new rules. For the average homeowner, however, there will be less net disposable income, not more, and that’s not something to be applauded.