For this post, we have Stephanie Majeran, a CPA and owner of WellRun Results, LLC, explaining some of the provisions of the tax bill being considered. I’ve then added some potential impacts that I see in the residential real estate market here in Des Moines.
If you turn on the news at all, you’ve probably heard the current buzz about tax reform. Given that Congress is trying to pass a tax reform bill for 2018 implementation, it’s best to review the changes now so you can be prepared.
First, please note that for tax year 2017, everything will remain as it has been in recent years, aside from some income level and deduction adjustments due to inflation.
The Tax Cuts and Jobs Act is being touted as a tool for simplifying our current tax system. Is our current tax system too complex—even broken? Yes, with a capital Y. Are major tax policy changes needed? Yes indeed. However, our current system is quite literally over 100 years in the making1. One bill will most likely not simplify and solve our country’s income tax issues, and it’s difficult to know what some of the long term effects will be. Let’s focus on how this bill will affect current or prospective homeowners. These items have proposed changes:
- Standard deduction increases
- Mortgage interest deduction
- Property tax deduction
- Capital gains exemption when selling your home
Disclaimer: This bill is still being debated in the House of Representatives and in the Senate, which means that some of the proposals here may not make it into the final version.
Standard Deduction Increases
In both today’s system and the proposed tax bill, you can only deduct mortgage interest and property taxes if you are itemizing deductions. This means that your itemized deductions must be greater than the standard deduction, which is $6,350 for a single person, or $12,700 for a married couple filing jointly. The proposed tax bill increases the standard deduction, to $12,000 for a single person, or $24,000 for a married couple filing jointly. This means that, regardless of other changes, fewer people will be able to itemize and deduct mortgage interest and property taxes, which may remove a driver for people who decide to buy instead of rent. Incidentally, fewer people will also be able to deduct charitable donations, so we may see a decrease in charitable giving as well.
Mortgage Interest Deduction
Currently, if you take the itemized deduction instead of the standard deduction, then you can deduct the mortgage interest you pay on mortgages totaling $1.1 million. This could include both a first and second home, as well as home equity mortgages taken out for home improvements. Keep in mind that this threshold is only based on the amount of mortgage debt you have, not on the actual value of your home(s).
Some proposed changes to this deduction would be to both reduce this threshold to only $500,000 of mortgage debt and disallow it on second homes and home equity debt. This will impact fewer people, however, if the standard deduction is increased.
From a real estate perspective: this can specifically impact markets with a higher proportion of second homes, such as Florida, possibly lowering those prices or reducing the number of buyers in the market. This can also impact the number of people who choose to take on home equity loans vs. cash out refinancing in the future, depending on interest rates and costs.
Property Tax Deduction
The property (real estate) tax deduction is also included with itemized deductions and right now you can deduct as much as you paid in the current tax year on all residential properties. However, if you make over $313,800 as a married couple, your itemized deductions are already subject to phase out. So while under the current law you can deduct large amounts of both mortgage interest and property tax, you may not be getting the full deductions if your income is above the income thresholds.
The proposed bill caps the property tax deduction at $10,000. This cap combined with the mortgage interest changes and the increased standard deduction is intended to ensure that less people itemize, thus supporting Congress’ intention of simplifying the tax system. Like the mortgage interest changes, the proposed cap would directly affect taxpayers who own more expensive homes. In Polk County, homes that are assessed at over $600,000 likely will have property taxes higher than $10,000, according to the SmartAsset calculator2. Therefore, this change is not likely to impact most of the residential real estate market in the Des Moines metro.
Capital Gains Exemption
We have rarely seen anyone pay capital gains on the sale of their main home. Currently, in order to exclude gains of $250,000 for singles or $500,000 for married couples, you must live in the house for two out of the past five years. If a seller does not qualify for that rule, they can still get a prorated portion of the $250,000/$500,000 gains exclusion. To discourage abuse, this exemption is permitted only once in a two year period.
Under the proposed bill, homeowners would be allowed the exclusion (same amounts) if they have lived in the house for five out of the past eight years and could only get the exemption once in a five year period. They have also added a phase out of the exemption depending on income level, where previously income level was not a factor. It does seem like they will keep the proration of the exclusion for ownership of less than five years.
From a real estate perspective, more homeowners may choose to stay in their current homes for longer, which could decrease inventory in the “first-time homebuyer” price ranges and make that even more of a seller’s market. Furthermore, in the higher price points, there could be fewer buyers (because those sellers are staying put), which could turn that market into even more of a buyer’s market. However, those sellers and buyers that need to move will still move.
While it is important to look at these proposed changes, we should emphasize that none of this is official law—yet. Many adjustments might still be made to all of the different pieces of the bill, including implementing it in phases, pushing back the year things go into effect, or omitting pieces of it entirely. The potential effects described above are simply educated guesses.
About our Guest Author
Stephanie Majeran is a CPA, which stands for both Certified Public Accountant, but also, and more importantly, Creative Problem-solving Adviser. She is the owner of WellRun Results, LLC, specializing in financial, tax, and data solutions. She has over ten years of experience across a broad range of areas including income tax, data analysis, research, and higher education. She has a B.S. in accounting from the University of Pittsburgh and a Master of Leadership Development with an emphasis on entrepreneurship and small business from Drake University. She is also a group exercise instructor, runner, Excel geek, dentist’s wife, and mother to an adorably active toddler and tiny furry running buddy. She has a passion for helping people reach their full potential.