This is sponsored content and was provided by Dan Beer.
The new federal tax bill is the subject of a lot of conversation, speculation, and misinformation. My goal is to talk through each of the key points in the bill that most closely affect real estate and bring clarity to what impact we are likely to really feel here in the 92127 and 92128 communities.
Interest Tax Deduction
There has been a lot of hysteria around the impact of the changes to the interest tax deduction. Under old law a homeowner could deduct the interest on a mortgage of up to $1,000,000. Under new law it has been reduced to interest on a mortgage of only up to $750,000.
At first glance it looks like a $250,000 impact. But it’s not. Remember that it is only the interest on the mortgage that is deductible.
Here is how the math breaks down. Assuming a 4 percent interest rate, the yearly interest on $250,000 is $10,000. It is that $10,000 that is deductible. Assuming a 35 percent tax bracket, that would cost the homeowner $3,500 more per year in lost tax benefit.
Let’s put this further in perspective. The above example implies a mortgage of $1,000,000 because it is only that $250,000 difference between the old law and the new law that is a potential impact on the market. If somebody has a mortgage of $1,000,000 it implies a purchase price of $1,250,000, assuming a traditional 20 percent down payment is made.
And now the truth about the potential impact of this law is starting to take form. While $3,500 is real money, the reality is that most $1,250,000 home buyers don’t make decisions on where they are going to live based on $3,500 a year (the actual cash impact on the taxpayer as seen above). Most $1,250,000 home buyers are in a position where $3,500 isn’t significant enough to alter their home buying behavior.
To further make the point. A $1,000,000 home buyer putting 20 percent down would have a mortgage of $800,000. So it is only $50,000 of their loan that won’t allow the interest deduction. At 4 percent the interest on $50,000 is $2,000. At a 35 percent tax bracket that implies a cash impact to the taxpayer of $700. Simply not enough to matter to the grand majority of million dollar home buyers.
My personal feeling if we feel a real estate impact from this tax bill it won’t be because of the interest tax deduction changes. Also, remember that if you already have a mortgage as of the date the bill was passed in December of this past year, you are grandfathered in and will not be impacted at all.
$10,000 Limit on SALT Deduction
This is the one that I believe will create the biggest impact on the market. Especially here locally in higher price point neighborhoods.
Under old law we could deduct an unlimited amount of state and local taxes, including property taxes, against our federal tax return. For high income folks, this was a key deduction saving them tens of thousands of dollars per year. For some even six figures of federal taxes saved.
Under new law the deduction is limited to $10,000. Again, this includes property taxes plus state income taxes. For many in our neighborhoods, their property taxes alone exceed the $10,000 limit. This is very likely to lead to a tangible market impact at higher price points where you already had people fed up with paying so much state tax and now they are going to incur a much heavier burden.
For example, a $500,000 earner, assuming they pay 13% state income tax and live in a $1,500,000 home, previously would have been able to deduct their $15k or so of property taxes (no including mello roos) plus the roughly $65,000 or so of state taxes they would have paid under old law. That would have provided them an $80,000 deduction against federal. At a 35% federal rate that would have been the equivalent of $28,000 in tax savings.
Today that same taxpayer would lose $24,500 of that deduction. Double those numbers for million dollar earners owning $3,000,000 homes and higher. They are facing tax impacts in excess of $50,000 and up.
While they may theoretically be able to afford the hit, this is a group of people already fed up and tired of being taxed so heavy for the privilege of living in California.
It is realistic to think that we are going to see some wealthy locals downsize their homes to not pay as much tax or they are simply going to leave the state. They may also make arrangements to locate their primary home in a state like Arizona and downsize their property here.
In other words, the higher price points are likely to be impacted. The National Association of Realtors forecasts that impact could be as much as 10% price declines in high income, high home value, high tax markets. Think Santaluz, Crosby, and the Trails. Followed closely be Del Sur Estates, Artesian Estates, and the Lakes. Plus of course higher end gated communities like Mirasol, Santa Monica, Bel Etage, Savenna, Salviati, and Ivy Gate.
This is still early in the game and we will learn a lot more over the coming months, but this is my early analysis. We will, of course, keep you posted.
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