Realty agents across the country warn that while the Republican tax-reform plan will lower the cost of homes, it could adversely impact high-tax regions by stripping away state and local tax (SALT) deductions.
On Wednesday, September 27, 2017, President Donald J. Trump announced a tax overhaul that promises major corporate and personal tax cuts. Its main agenda is to be a “rocket fuel” to the economy with American manufacturing and job growth as its focal points.
“People want to see tax cuts,” said Trump. “They want to see major reductions in their taxes and they want to see tax reform. And that’s what we’re doing.”
The proposal received initial criticism that it would dump trillions of dollars of debt onto the federal government which already owes $20 trillion with $550 billion in annual deficit.
Most of the skepticism is due to the White House releasing little information on how they plan to compensate for the cuts. Except, of course, for the anticipation of increased tax revenues generated by economic growth and the elimination of various tax exemptions.
A one-page outline of the Republican leadership’s tax-cut plan has been in circulation days before the announcement.
While it confirmed that the administration would preserve and even double the home mortgage interest deduction, it also indicated that a number of deductions would be eliminated with the reform. This includes personal property taxes and real estate taxes — both of which can be deducted from individuals’ federal returns.
By doing away with these benefits, homeowners who itemize these deductions in high-tax states like New Jersey, New York, and California might end up spending more.
“The tax reform proposed by the Republican leadership will eliminate the incentive for people to buy homes, shrink the middle class, and raise taxes on hundreds of thousands of California homeowners,” says in an email by Geoff McIntosh, president of the California Association of Realtors (CAR). “The doubling of the standard reduction, coupled with the elimination of state and local tax deductions, such as property taxes, will adversely impact California and its housing market. The average California home buyer could end up paying $3,000 more a year in taxes.”
Aside from slowing down the housing industry, McIntosh also said that the new tax policies could be detrimental to the economy, considering the fact that the housing industry creates an average of 2.5 million private sector jobs yearly.
Not everyone, however, shares the same sentiment. Some economists believe that the tax reform would bring in benefits that outweigh the drawbacks, particularly towards home buyers.
“There are several variables, but it would reduce home prices,” says Fred Foldvary of San Jose State University. “Right now, home prices are propped up by implicit subsidies, such as deductions for mortgage interest, property taxes, and other benefits. All of these puff up the value of residential real estate.”
Although the elimination of property-tax deductions can reduce home prices, historical data on the Bay Area home prices suggests that the change would be negligible.
To put things in perspective, property prices in the Bay Area have been rising steadily from 7 percent to 15 percent per year.
According to Christopher Thornberg of Beacon Economics, the tax reform can only reduce home prices by only 0.5 percent.
“You have to put that in the regular context of a market where home prices are going up very rapidly,” says Thornberg.
In markets like the Bay Area where real estate prices are substantially higher, double mortgage interest deductions also can’t be underestimated.
According to Denise Welsh, President of the Silicon Valley Association of Realtors, the tax changes could effectively incapacitate the Bay Area market.
“Our whole housing market is intertwined by those tax deductions,” says Welsh. “Eliminating those deductions may not impact people in some parts of the country, but it certainly would have a very significant impact to the local area.”
People who plotted their entire financial plan around SALT deductions will also be largely affected by the reform, especially those who took out large home mortgage loans in high-tax states. Not only could the value of their properties shrink, the absence of these deductions might knock their financial projections off course—potentially leading to an exodus of Bay Area homeowners.
NAR: Major Reforms Shouldn’t Come at the Expense of Homeowners
The National Association of Realtors (NAR) also provided their response to the Republican tax-reform proposals.
Although the group acknowledges the need for tax reform, they oppose the idea of pushing SALT deductions out of reach.
According to NAR, eliminating these incentives would make home-buying less attractive, slow down the housing market, and hamper the economy’s growth—completely against what Republican government was hoping for.
“Major reforms are needed to lower tax rates and simplify the tax code, but it shouldn’t come at the expense of current and prospective homeowners,” says NAR president, William E. Brown.
NAR is the biggest trade association in the United States, comprising of commercial and residential brokers, property managers, counselors, and other real estate professionals.
Breaking Down The GOP’s Tax Plan
The tax-reform proposals were pitched by Trump way back in his campaign for the presidency. It reduces the tax brackets from seven to four, including one for people who earn less than $25,000 a year and three for those who make more.
Citizens in the lowest bracket are not required to pay any taxes at all, while the succeeding three brackets are required to pay 10 percent, 20 percent, and 25 percent respectively.
For businesses, the lower corporate tax rate is pointed towards discouraging top firms from hoarding money overseas. And from the Republican leadership’s perspective, the reform will also enable more business investments—thus, creating jobs, mobilizing the local competition, and boosting the nation’s economy.
It’s worth noting that the Republican tax-reform outline is not final, which means the elimination of these tax deductions is not completely guaranteed.
A statement later released by President Trump also addressed the gaps in the outline and promised to make the necessary adjustments in the next few weeks.
White House economic adviser, Gary Cohn, also reassured that the office of the president is open to negotiation when it comes to preserving the breaks.
Aside from mortgage interest, the deductions for taxable charitable contributions will also be preserved.
As more details come out, I will update this article.
I am a Real Estate Advisor and Investor. I have a background in tech startups within the real estate space.