Tax profiles aren’t quite as individualized and unique as fingerprints or snowflakes, but the variety of households, income levels, state and local tax rates, and job markets in the U.S. leads to confusion when laws like the recent tax reform bill are passed. Tweaks to the tax code that benefit one group in one metro area are detrimental to another group in a different area — so how can you determine what it means for you?
Understanding the local economy is the first step toward uncovering how changes to the tax law will influence your bottom line. When you have a handle on what’s happening near you, it becomes easier to estimate how housing might shift in the future as the effects of the bill manifest. Local housing and employment markets contain clues to the future if you know where to look, and can even help you determine where it’s risky to invest in real estate (and where it’s more stable).
For local real estate experts, the two biggest tax-code changes to watch are the decreased mortgage interest deduction and the state and local tax (SALT) deduction cap.
Mortgage Deduction: Not A Big Deal … Except Where It Is
How did we reach these conclusions? HouseCanary examined 2017 loans originated by MSA that fell between $750,000 and $1 million to see how many homes would be impacted by the new laws. We estimated a 1-percent financing benefit and shaved 25 percent from the deduction on a 4-percent mortgage loan to determine how mortgage interest deduction could affect different parts of the country.
The new tax law is decreasing the amount of mortgage interest that a household can deduct on its annual taxes. Homes that closed before December 15, 2017, are “grandfathered” in, but after that date, the new limit on mortgage interest deductions dropped to $750,000 from $1 million (this limit also applies to second homes).
Because buyers won’t be able to deduct at least part of the mortgage interest paid on a new home, this lowers affordability of homes between $750,000 and $1 million. In most markets, homes in that price range are luxury properties, representing some of the highest-priced real estate in the area.
In other markets, however, that price range is considered average. There are 10 MSAs in particular that together represent 82 percent of the lost mortgage interest deduction benefit, and all of them are already struggling with affordability issues; four of them are in California.
A neighborhood’s median home value or median sales price can show how the “average” home in a certain area is priced. In some parts of San Francisco, arguably the most expensive market in the country right now, the median home value is more than $1 million, so it’s fair to assume that the tax bill is going to have a more substantial effect in San Francisco than in parts of the country with much lower median home values.
Home buyers in those markets may need to reassess their spending levels, cut corners, or opt out of the market altogether if the homes they’re reaching to buy become increasingly unaffordable. They may look to more affordable neighboring communities and opt for a longer commute in order to achieve homeownership — and then it’s only a matter of time before prices start to spike in those neighboring communities, too. Smart buyers and investors will prioritize keeping their fingers on the pulse of neighborhoods and even block areas where they hope to own (or currently own) homes.
Hold the SALT
How did we reach these conclusions? We looked at the median household income, effective state income tax rate, median valuation (calculated as the median automated valuation for each MSA) and effective local property taxes to determine which parts of the country have SALT taxes that average more than $10,000 per filer.
Another potential impact to homeownership from the tax bill involves SALT taxes, which include property tax. The bill has capped SALT tax deductions at $10,000 across the board — but SALT varies from state to state and within states, so that some citizens are paying more in SALT and some are paying much less, depending on where they live.
If homeowners are paying relatively high taxes on their properties because of where they live, this tax change could provide an incentive for those who can to move to a different city, county, or even a new state as they seek lower property taxes. Some homeowners in states with high SALT rates and rising home values may find that they can’t afford to own a home at all anymore without the deductions.
For most taxpayers in most counties, the SALT cap isn’t a big deal, but there are 66 of the 3,134 counties in the country that can expect to see some fallout from the SALT cap because of relatively high SALT rates.
So now what?
Homeowners or aspiring home buyers who live in counties that have both relatively high home values and SALT rates are going to feel the bill’s impact most drastically.
What will they do as a result? That depends in large part on their individual circumstances — but in an era when working remotely is increasingly popular, we could see an exodus from some of the most-affected markets as buyers look outside the metropolitan area for potential homes … and sometimes even in a different state.
Although California has more markets than any other state at risk for tax-bill impact, the moderate climate and natural beauty of the state may ameliorate some of the “exodus” effects because it’s an attractive place to live in spite of the affordability crisis.
Other markets, however, may not be so fortunate; New York, New Jersey, and Boston are all located in less moderate climates and have fewer natural features to recommend them to transplants. Those areas may see eligible employees leaving the city centers more quickly than they can be replaced. If that happens — inside or outside California — then the tax money needed to drive local industry and support services will begin to dry up, leaving the areas in question bereft of funds and workers.
Even if the worst-case scenario doesn’t manifest, areas with high home values and high SALT rates may see some softening in real estate as buyers struggle to afford the American Dream and the real estate market stumbles as a result.