Christopher D. Munchhof
Tax Changes for Real Estate in 2018
Early drafts of the recently signed Tax Cuts and Jobs Act had many people panicking about how the proposed laws would affect real estate. The National Association of Realtors predicted that housing prices would drop in every state, including up to 12% in California. Ok, maybe the only people "panicking" were those who worked in the real estate industry(...just giving you guys a hard time). The 45% of Californian's who don't own their home could argue that a 12% decrease in home prices was a good thing, but I digress. So now that the bill has officially been signed into law, which provisions specifically impact real estate?
State and Local Tax Deductions Capped
This is probably the most talked about provision of the new law. Deductions for state and local taxes will be capped at $10,000 per year. Originally the $10,000 cap only allowed property taxes while all other state and local taxes would no longer be deductible. Ultimately, compromise was made and the $10,000 cap was changed to include deductions of state income and other local taxes as well.
This will mostly affect people who have some combination of high income and high assessed values on property they own. For example a married couple who earns $100,000 a year and owns a $500,000 home, would still most likely see all of their deductible taxes fit under that cap. However, if that couple's income went up to $150,000, the increases in their California income taxes would shoot their taxes past the cap by about $2,000. Losing that $2,000 of deductions would raise their federal taxes by $440 per year.
It's important to note that the $10,000 cap applies to taxes not attributable to income producing activities. For example, there is no cap on deductions for property taxes on rental property.
Mortgage Interest Deduction Limited
For all loans taken out after December 15th, 2017, mortgage interest will be deductible on the first $750,000 of combined principal for a first or second home. This is a reduction from the previous limit of $1 million. Mortgages taken out prior to December 15th, 2017 remain deductible up to the first $1 million even if the loan is refinanced in the future.
At a 5% interest rate, a married couple in the 24% tax bracket who took out a new $1 million dollar mortgage would pay about $3,226 more in federal income tax in the first year of the loan than if they could deduct interest on the full $1 million.
Home Equity Line of Credit Interest Deduction Eliminated
Starting immediately, the the deduction for interest on a home equity line of credit is eliminated. There is no grandfathering in for these loans. So even if you took out the home equity loan prior to the enactment of the new law, your deduction is still eliminated starting in 2018.
There is a silver lining. If you used the proceeds of your home equity loan to make certain improvements to your home, the IRS considers the loan as "acquisition debt" and you may still deduct the interest for that portion of the loan.
Standard Deduction Increased
The standard deduction was increased from $6,350 for individuals and $12,700 for married couples, to $12,000 and $24,000 respectively. While increasing the standard deduction doesn't directly affect real estate, what it does do is shrink the potential tax savings someone would receive by owning a home vs. renting.
Using the couple who earns $100,000 with a $500,000 home for an example again, by itemizing their deductions, they'd write-off about $20,000 in mortgage interest, $9,000 in taxes and a handful of other deductions for total deductions of $30,000. Under the previous law, these write-offs would be worth $17,300 in extra deductions vs. the old standard deduction of $12,700. Under the new law however, the difference of owning a home vs. renting only results in an additional $6,000 of deductions($30,000 of itemized deductions - $24,000 standard deduction = $6,000).
So owning a home for most people will give them the same write-offs they had with the previous law, but because the deductions for people who are renting have increased so much, the tax savings for owning a home is much less significant relative to renting. Many people believe that because renters now have a bigger deduction, their is less incentive for them to buy a home. It seems unlikely that this would have a significant impact on the housing market because tax savings usually isn't even one of the top five reasons people cite for deciding to buy a home.
Benefits for Landlords
Expanded Section 179 Deductions and 100% Bonus Depreciation. Section 179 allows businesses to deduct certain expenses up front instead of having to spread the deductions out over several years. Previously, landlords were exempt from using Section 179 to immediately deduct personal property in residential rental units such as furniture, appliances, carpeting, etc. Additionally, and somewhat redundantly, the new law raises bonus depreciation from a first year deduction of 50% of the cost of new property used in business to 100%. So even items that may not fall under Section 179, can still be fully deducted in the first year they are put into service.
Pass-Through Tax Deduction. Landlords who own their rental properties as sole proprietors, LLC's, partnerships, or other "pass-through" entity can deduct up to 20% of their net rental income on top of all of their other rental deductions. This deduction will also apply to most real estate agents who earn up to $157,500 for singles or $315,000 for married couples. The deduction applies to business income(commissions reported on a 1099 for example), but not wages or salary.
Sale of Personal Residence Exemptions Remains
One proposal that didn't make the final cut was extending the number of years owners are required to live in a residence prior to selling in order to exempt the maximum $500,000 of capital gains for married couples or $250,000 for individuals from taxes. Both the House and Senate bills proposed extending the requirement to living in the home for 5 years out of the previous 8 prior to selling.
Of course in a great example of how government works, despite both the House and Senate including the provision in their proposals, it was stricken from the final law. The previous requirement of living in a home for 2 of the previous 5 years to claim the full exemption remains in place. Most analysts predicted that extending the years for this requirement would have tightened housing inventory even further and that may be a big reason it was ultimately left out of the final law.