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Impact of Proposed Tax Plan on Real Estate

The House and Senate recently approved versions of President Trump’s tax reform bill. Though these two proposals still require reconciliation before final legislation can be passed, there are some significant changes that could adversely impact real estate.

Reduction in Mortgage Interest

The House version of the bill includes up to $500,000 of mortgage interest that homeowners can deduct from their taxes. The Senate version keeps this amount at the current allowable $1 million.

If the $500,000 limit is instated, this could adversely affect states such as California that have high-priced residential property. 49% of Californians have a mortgage over $500,000 while 14% hold home loans of $1 million or higher. This reduction in the deductibility of mortgage interest may potentially affect approximately ½ million Californian homeowners, increasing their annual taxes by over $3000.

NOTE: As of December 14th, Congress has merged their two versions of the proposed tax plan, with the goal to have it ratified by the President before the end of 2017. The plans splits the difference of the mortgage interest deduction limit between the Senate plan’s $1 million and the House’s $500,000 to a mutually agreed upon $750,000 maximum.

Property Tax Deductions

Both houses of Congress include a $10,000 property tax deduction limit though the Senate‘s original version was going to negate this deduction altogether. In California, 9% of homeowners pay that amount or more in yearly property taxes with a good portion of these homeowners located in Silicon Valley.

Elimination of State & Local Tax Deductions

Also included in the Congressional reform proposals is completely eliminating the ability to deduct both state and local taxes, a deduction that has been part of the United States tax code since 1913. Over 6 million upper-middle and middle class Californians would feel the burden if this deduction is mothballed.

Increase in Standard Deductions

The new tax plan is calling for an increase in the standard deduction across the board. For those Married Filing Jointly, the deduction would jump from $12,700 to $24,000. This would result in 94% of taxpayers utilizing the standard deduction rather than taking advantage of the mortgage interest deduction. According to the National Association of Realtors (NAR) and the California Association of Realtors (CAR) in addition to the National Association of Home Builders, this could cause a downturn in the value of housing, especially in states like California where home prices are significantly above the national average.

This anticipated decline in home value could dramatically affect homeowner equity, in some cases eliminating it altogether. This would also be detrimental for those people who have to sell. And, just like in 2008, banks would also suffer the impact of this widespread decline in property worth.

A recent article in the San Jose Mercury News written by Steve Butler focused on the potentially devastating impact this tax plan would have on real estate and homeowners.

Says Butler in his article,

My concern is how the reduced deductibility of homeownership may impact, overnight, the appraised value of residential properties—especially in places like California, where median prices drive mortgages and property taxes higher than the proposed caps offered by tax reform proposals.

People buy homes based on what they calculate they can afford in after-tax dollars. Anyone sophisticated enough to buy a home has figured out the extent to which their monthly costs, based on current tax law, will cost them in take-home pay. The maximum purchase price of their new home is pegged at what their monthly take-home pay budget will support.

It stands to reason that home prices could drop if the current tax proposals pass. The loss of value would be more severe in higher-priced homes where mortgage interest and taxes are affected by the proposed reform.

But the picture gets darker when we remember that homes are purchased largely with “other people’s money”—namely, bank financing with 10 percent or 20 percent down.

A drop in the value of Bay Area homes could erode, or possibly even wipe out many homeowners’ equity—at least on paper, and maybe for real if the owners have to sell.

This is bad for the owner, but it can be worse for the banks, collectively. It’s bad enough for the individual homeowner, but it’s bad for all of us if it affects bank solvency—again.

Home prices are said to be on an “elastic” demand curve. This means that any change in demand has a large impact on prices. By comparison, coffee has an “inelastic” demand curve because people want a cup of coffee no matter what it costs. So, if demand for homes above, say, the Bay Area median price drops to any extent, prices in this sector may drop a lot.

Meanwhile, when home equity sneezes, banks catch a cold. We all know what that looks like, and we don’t want to go through it again.

Real Estate Industry in Opposition

NAR, CAR and other organizations involved in the real estate industry are fervently working to minimize the potential impact of this proposed tax reform on the nation’s real estate industry. The first thing you see on NAR’s website is a call to action to contact Congress regarding tax reform and protecting middle-class homeowners.

California Association of Realtors (CAR) President Geoff McIntosh says, “Congress should look at ways to incentivize and increase homeownership rates, not increase taxes on families wanting to buy a home.”

McIntosh said losing the tax deduction combined with a twofold increase of the standard deduction would remove the incentives for home buying and negatively impact California’s housing market. He predicts the average California home buyer could end up paying $3,000 more a year in taxes.

The ramifications to real estate if this tax reform legislation is ratified are potentially significant and could be especially detrimental in California and Silicon Valley. With plans underway to finalize and pass this bill before the end of the year, we encourage you to contact your Congressperson to safeguard your homeowner deductions as well as the value and equity of your home.

The Dawn Thomas Team artfully unites special homes with extraordinary lives in Silicon Valley and Santa Cruz County. Contact us today and we can assist you in selling or buying your home.

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