Tax Bill Proposed Changes & Their Effect on Real Estate

The new tax bill that has recently passed the House and Senate in two slightly different but similar version will have an effect on the real estate markets in Connecticut, New York and New Jersey.  In the first part of this two-part email, I will discuss the three aspects of the bills that will directly or indirectly make the cost of owning real estate in the Tri-State area more expensive.

Real Estate Taxes

Both the House and the Senate bills contain a limitation on the tax deductibility of real estate taxes.  They both limit the amount of real estate taxes that can be deducted to $10,000.00 which is an average to below average amount of real estate taxes paid in New York and New Jersey. In addition, in some of the more affluent New York and New Jersey suburbs, it is not unusual for real estate taxes to be $15,000-25,000. On larger homes in those areas, real estate taxes can exceed $25,000 or more. As a result, many taxpayers in New York and New Jersey will pay another $330 in federal income taxes per year (at a 33% tax rate) on every $1,000 of real estate taxes in excess of $10,000 (e.g. $3,300 per year on real estate taxes of $20,000).

Mortgage Interest

Similar to real estate taxes, the new tax bills limit the tax deductibility of mortgage interest. The House bill limits the deduction to the interest on loan amounts of $500,000 or less. The Senate bill leaves the limitation on the current loan amount of interest on loan amounts less than $1,000,000. These two versions of the bill will get reconciled between the two Houses in the Conference Committee.   Using simple logic, it would appear that to reconcile the two bills the loan deduction may be reduced to interest on loans of less than $750,000. However, with Congress, there is no such thing as “simple logic” so this could end up at $500,000, $1,000,000 or anywhere in between! Using the $500,000 amount in the House bill and, again, at a 33% federal tax rate, for every $100,000 of debt (at 4% interest rate or $4,000 a year) , the actual cost of the loss of tax deductibility will be $1,333 per $100,000 (e.g. $3,332.50 on a loan of $750,000).

State Income Taxes

The tax bills also remove the tax deduction for state income taxes. That is, there will no longer be a federal tax deduction for the income taxes that are paid to the states. While the limitations on the amounts of deductibility for real estate taxes and mortgage interest will mostly affect those purchasing homes in the upper middle and higher end of the real estate market, the loss of a tax deduction on state income taxes will affect everyone. In New York and New Jersey, this will compound the lost deductions on real estate taxes and mortgage interest resulting in an even larger tax increase for those us living in these states.  At an approximate blended state income tax rate of 6.5% (i.e. NY/NJ), for each $100,000 of income, there will be a $6,500 loss in deductions. This will mean a federal tax increase of $2,145 per $100,000 of income (at a 33% federal tax rate).

Capital Gains Exclusion Changes

Another change is to the provision that allows homeowners to exclude from their taxable income up to $250,000 in capital gains ($500,000 for married taxpayers) from a sale of their primary residence. Under the plan, to qualify for this break, homeowners must have owned and lived in the home for at least five of the last eight years. Currently, the rule is two of the last five. Taxpayer use of the exclusion would also be limited to one sale every five years, rather than one every two. In addition, under the House bill, you begin to lose the gains exemption if adjusted gross income (in a look-back period) exceeded $500,000 if married or $250,000 if single.

Summary

These  tax changes taken together will greatly increase the amount of federal taxes that will be paid by many homeowners in the Tri-State area.  There will be more of an effect in New York and New Jersey due to the higher real estate taxes in these states.  The most significant increase will fall on the upper middle class. They will see real dollar increases in federal income taxes of many thousands of dollars each.