While lots of uncertainty remains, overhauling the federal tax code includes several proposed changes that may result in altered choices for some homebuyers and owners. The U.S. Senate bill and the House bill differ on numerous points, so the dickering involved in the reconciliation process could dramatically change the final proposal. However, let’s look at what is currently on the table, from both proposals, in terms of the potential impact of reform on residential real estate.
There are three important residential real estate taxation changes proposed. They include:
- Mortgage interest deductions
- Property tax deductions
- Capital gains tax exclusions
Mortgage Interest Deductions
Today, qualifying mortgage interest can be deducted on residential loans up to $1 million dollars. What’s more, this loan cap can apply to a maximum of two houses—a primary home and a vacation home. You can also deduct interest on an additional qualifying home-equity loan up to $100,000.
The House and Senate have proposed different changes to this deduction. The House wants to halve the loan-cap for qualified mortgage interest deductions to a maximum of $500,000. It also proposes to eliminate this deduction on a vacation home, making it available only on a primary residence.
The Senate wants to maintain the $1 million cap, but its bill proposes to eliminate the ability to deduct interest on a qualified home equity loan.
So why should you care?
Proposed changes, particularly the House version, could impact homebuyers in areas with high home prices. A cap of $500,000 in California or New York may be easily reached, even by those looking for relatively modest accommodations. Minus a deduction for interest for higher mortgages, some buyers may opt for a less expensive home.
Property Tax Deduction
Currently, homeowners can deduct state and local (property) taxes (SALT) from their federal tax bill. However, this deduction is targeted by both the House and Senate versions of federal tax reform.
In the House version, homeowners will be able to deduct property taxes up to a maximum of $10,000. In the Senate version, property taxes will simply not be deductible.
Again, the proposed changes tend to impact certain markets. While homeowners in most parts of the country pay less than $10,000 annually in property taxes, taxpayers in states with high property taxes and high home prices will surely feel a wallet pinch if either option remains in the final tax-reform plan.
Capital Gains Tax Exclusions
Both the House and Senate bills appear to be in lockstep regarding changes to capital-gains tax exclusions. Currently, you can use a federal tax exclusion to protect up to $250,000 in profits as an individual ($500,000 for couples) from capital-gains taxes when you sell your home. To qualify, the property you sold must have been your primary residence for at least two out of the past five years. There is no limit on how many times this exclusion can be used, if the residency requirement is met.
Both the House and Senate propose to make a simple, but highly important, change to this exclusion—they propose to extend the time of residency to five out of the past eight years.
This could have a significant impact on some homeowners. For example, if you are considering buying a primary residence, but your lifestyle is fluid, you may owe capital gains taxes on profits if you sell before the five-year residency requirement.
The proposed requirement also dashes plans for homebuyers who have rentals that they planned to convert to primary residences before selling. Because current law does not limit the number of times this exclusion can be used, some enterprising people move into their rental properties for two years before selling them. This shelters as much as $500,000, for married couples, from capital gains taxes for each rental property.
Hypothetically, a couple nearing or just entering retirement could liquidate three or four houses in a period of six to eight years using the current exclusion. This would protect significant profits on all properties from capital gains taxes—and potentially add thousands to a retirement nest egg. Under tax reform, a similar liquidation plan would require a 15-to20-year commitment—a much more onerous proposition.
It certainly makes sense to add these potential tax changes into your thinking process if you are buying, selling or accumulating residential property. But, like real estate, itself, much of the impact—if any—will depend on location, location, location.
This blog is for informational purposes only; we are not in the business of providing tax or legal advice and we generally recommend seeking the advice and counsel of a tax professional before taking any action that may cause a material taxable event.