On November 2, 2017, the Republican Party unveiled it’s tax plan, and some of the most interesting aspects of it relate to the housing industry. There are three key points to consider:

  1. A reduction in the amount of mortgage interest that can be deducted.
  2. A property tax deduction cap.
  3. Capital gains exemption limits which are used by homeowners that sell their property.

First and foremost, it is important to note that this plan is a long way from passing into law; but it is worth looking at the potential impact on the housing industry nonetheless.

Mortgage Interest Deduction

At present, you can claim an itemized deduction interest paid on your mortgage valued up to $1.1 million used to either purchase a second home or improve your existing property. Under the new plan, the cap remains in place for existing homeowners but limits it to $500,000 for any homes bought in the future.

It also limits the mortgage interest deduction to one main home which means you can no longer claim it for vacation properties. With the new plan, a homeowner who buys a home with an $800,000 mortgage at an interest rate of 4% would only be able to deduct $20,000 instead of $32,000.

Presumably, the Republicans are looking at the fact that it won’t impact a large percentage of future homeowners. As of September 30, 2017, the median price of a home in the United States was $245,100. CoreLogic data suggests that only 3% of mortgages in the U.S. cost more than $500,000.

However, the lower cap is likely to hurt first-time buyers in the top-end of the market and have a severe impact on people in certain regions. In California’s Bay Area, for example, sales of single family homes for under $500,000 fell by 17% in June 2017 compared to the June 2016 figure. This plunge is due to the sheer paucity of low-cost homes in the region.

While only 6.5% of homes in the Houston Metropolitan Area cost $500,000, 63% of properties in San Diego and 90% of homes in San Jose cost over half a million dollars. According to the proposed bill, there is also no ‘phasing in’ period as the ceiling is lowered immediately.

With the possibility of property costing tens of thousands of dollars more overnight, the plan will probably change the plans of people who were initially planning to move. Also, home value increases in the long-term will chip away at the deduction’s value if the cap is not raised over time.

Property Tax Deduction Cap

The plan to cap the deduction for a property at $10,000 would also deal a major blow to the high-end markets. At present, all local and state taxes are deductible in the ordinary tax. During the lead up to the release of the bill, the issue of local tax treatment was one of the most contentious. Property taxes were only spared from the ax after Republicans in high tax states such as New Jersey and New York threatened to torpedo the bill.

Even so, investors and the real estate industry are extremely unhappy with the state of affairs, and the announcement of the bill caused the share price of several major homebuilders in the luxury market to tumble. On the day of the bill’s release, the share price of KB Home fell 3%, Lennar fell by 3.3%, and Toll Brothers shares plummeted by over 6%!

Capital Gains Exemption Limits

At present, there is a provision that enables homeowners to exclude up to $250,000 in capital gains from their taxable income; the figure rises to $500,000 for married couples. The new bill will make it more difficult to qualify for this particular tax break. You are only eligible if you owned and lived in the property for a minimum of five of the last eight years.

Also, you will only be able to use the exclusion once every five years; at present, you can use it once every two years. Finally, homeowners start to lose the exemption if their adjusted gross income exceeds $250,000 or $500,000 for a married couple.

Is It a Problem?

According to the chairman of the National Association of Home Builders, Granger MacDonald, the bill “abandons middle-class taxpayers in favor of high-income Americans.” He continued by saying the bill would “put millions of homeowners at risk.” Data from the Tax Policy Center shows that the mortgage interest deduction was claimed on almost 30 million tax returns.

Unsurprisingly, Republicans refused to acknowledge this line of thinking and believe any negative impact will be short-term. In the long-term, they feel that people will adjust and the worst case scenario is that new homeowners will spend less on decorating their property.

Final Thoughts

It seems unlikely that the new Republican bill will help reverse the fall in homeownership in the United States. According to the United States Census Bureau, the homeownership rate as at October 31, 2017, is 63.9%. Those who benefitted from extremely low-interest rates have little interest in moving as things stand which means the number of homes for sale is dwindling.

There are several points of contention, but the mortgage interest deduction plan seems to be the most controversial part of the bill. The thing is, economists have complained about the deduction for years; they believe it is wasteful and benefits the wealthy over the poor and homeowners over renters.

The President of the National Association of Realtors, William E. Brown, criticized the bill and indicated that the real estate industry would fight lawmakers over the proposed changes.

Ultimately, parts of the plan are akin to a tax on selling a home which will make homeowners even less likely to sell. Those looking for properties at the high-end of the market will also suffer as will people who live near coastal areas where home prices are much higher. Luxury homebuilders will also feel the pinch, and with so many powerful enemies, the Republicans have a fight on their hands to turn this bill into law.