What Does the New Tax Legislation Mean for Homeowners?

Jan 26, 2018

Family in front of homeOn December 22, 2017, the Tax Cuts and Jobs Act was signed into law – enacting significant changes in how many U.S. taxpayers calculate their gross taxable income in 2018. A major component of the new legislation includes several provisions that could affect the costs of home ownership in the Bay Area. To help shed light on how the new tax code could impact your tax filing next year if you are a homeowner or first-time homebuyer, we’ve provided a brief overview of important aspects of the law that deal directly with this:

New limits on the mortgage interest deduction: If you took out a home loan before December 15, 2017, you could write off interest payments up to $1 million in mortgage debt from your taxes in 2017. And fortunately for you, you can continue to do this in the upcoming years, as your mortgage has been grandfathered in according to the previous tax laws. But for homes purchased after Dec. 14, 2017 and until 2026, this interest deduction caps out at $750,000 of mortgage debt, which can be used for a primary home or secondary residence (e.g. vacation home).

For some perspective, most homebuyers in the U.S. take out mortgages for substantially less than $750,000. Accordingly, the new restrictions on mortgage interest deductions alone won’t increase taxes (and thus housing costs) for most potential homebuyers. However, many of those considering buying in certain high-priced markets of the Bay Area where homes average upwards of $1 million could certainly feel the pinch.

Can you still deduct interest payments from a home equity loan? The answer to this question is a bit murky but basically boils down to “It depends.” Under the new legislation, interest paid on home equity loans will no longer be deductible through the end of 2025. However, the exception to this may be if you have a home-equity loan with funds taken out to substantially improve your home. To learn more, read the Orange County Register’s article “HELOC loans might still be deductible under new tax plan.”

Property, state and local income tax deductions max out at $10,000: Prior to 2018, all of your state and local property taxes as well as your state and local income taxes could be deducted from your federal filings. This year that changes as all property state and local income taxes are combined as a single deduction that cannot exceed $10,000.  This maximum “SALT” deduction applies to both individual tax payers and those filing jointly.

For many homeowners with high value properties and high state income taxes (e.g. California), $10,000 is substantially less than what they pay in terms of property and state income tax bills. According to CNBC, the average SALT deduction for taxpayers in New York, New Jersey and California has been about $20,000 in recent years. Not surprisingly, certain states are already seeking ways to circumvent the increased tax burden.  For instance, a bill has been introduced in California to allow taxpayers to pay a portion of their state taxes to a state charity– enabling them to deduct the amount of this charitable contribution on their federal form. Find out more in “Here’s how Californians may be able to skirt SALT cap” from CNN Money.

Capital gains exclusion remains in place: If you’re a homeowner planning to put your home on the market in 2018, you can rest assured that you can still exclude up to $500,000 of capital gains from taxation ($250,000 for individual filers). Of course, this is contingent on having used the home as a primary residence for two of the past five years.

 

The standard deduction nearly doubles: As you likely already know, the IRS doesn’t expect taxpayers to pay the government on the entire amount of their income. Recognizing that people need money to live, it offers taxpayers two options for reducing their taxable income: taking a standard deduction or itemizing deductions. In 2018, that standard deduction jumps from $6,350 to $12,000 for individual filers and from $12,700 to $24,000 for joint filers.

 

With such a dramatic increase in the standard deduction, it’s expected that fewer people will itemize their deductions and decide instead to take the standard deduction. For most people, it simply won’t be financially worthwhile to itemize deductions. According to Zillow, only 14.4 percent of homes are worth enough to make it beneficial to itemize deductions (including mortgage interest) under the new GOP tax code. As Forbes explains, the increase in the standard deduction will cancel out the benefit of itemizing for many couples, since their mortgage interest and $10,000 SALT deduction combined won’t exceed $24,000.

 

While it’s difficult to say what the effect of reduced tax benefits for home ownership will have on individual housing markets, some industry experts project they might cause a price drop in homes of between 8 to 12 percent in the Bay Area. And if this is the case, this could open doors for first-time homebuyers. At the same time, it’s important to keep in mind that important elements of the tax reform are subject to interpretation, and as such, are still being challenged and tested, and could possibly be amended throughout the year with retroactive effectiveness.