Federal Tax Reform: 3 States Could be Hit Hard - Article | Think Realty
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Federal Tax Reform: 3 States that Could be Hit Hard

Late last week, the U.S. Senate passed a sweeping federal tax reform bill that has been highly controversial and was approved wholly along party lines, with all but one republican senator voting for the bill and all democrat senators voting against it. Among other things, the bill will affect state and local taxes (SALT) on income as well as property and real estate taxes. At present, many taxpayers and investors take whole or partial deductions on property taxes, and most homeowners receive a mortgage-interest deduction (MID).

Changes to Property Taxes and MID

In the Senate’s original version of the federal tax reform bill, which has been passed but now must still be reconciled with the House bill and then signed into law, all SALT deductions would have been removed entirely. However, the passed legislation includes an amendment that permits up to $10,000 in state and local property taxes, which reconciles the Senate and House versions in this regard.

The House bill also proposes capping mortgage interest deductions. At present, individuals may deduct up to $1 million in mortgage debt However, the House plan proposes cutting that cap in half, making the maximum deduction $500,000 for future homeowners. The $1 million cap would remain in place for homeowners currently receiving it. The Senate bill does not address MID, so before the final legislation is signed, this must be reconciled.

Harder-Hit States Will Have Heavier Existing Tax Burdens

Critics of the bill complain that it will affect residents of states with existing higher tax burdens more than those who live in states that already tax lightly. For example, a state with relatively low property tax rates or no or low income taxes will likely be less significantly affected since residents have relatively light tax burdens already. On the other hand, residents in states with heavier tax burdens, such as California, New Jersey, and New York, are more likely to lose access to at least some of their disposable income if the lower caps on deductions make it through to the final legislation.

Nick Samuels, vice president at Moody’s Investor Service, predicted, “The SALT change would…reduce financial flexibility by increasing political resistance to tax increases at the state and local levels.” He also said that he believes residents in states with heavier tax burdens tend to already have less disposable income, so removing options for deductions could further reduce that spending flexibility.

Chris Raulson, a wealth strategist at Raymond James, agreed. “The bottom line is for families in these particular states that have not only higher state tax rates and higher state income taxes and real property taxes, the loss of deductions will impact them much more than families in states with lower state income taxes and real property taxes.”

What the Federal Tax Reform could Mean for Real Estate Investors

At present, all of this is still largely hypothetical since now the Senate and House bills must be reconciled into one piece of legislation. If you are worried specifically about the MID caps, then this is good news for you. Generally, in these situations the Senate’s version of a bill tends to rule during this process.

However, for investors taking MID or paying property taxes and taking some level of deductions on those payments, if you have more than one property, the losses could add up. The best thing to do is lay politics aside and track the progress of this legislation closely, even if the process is distasteful to you. The fact that the House and Senate passed such similar proposals is being treated by proponents of tax reform as a triumph, and rightly so: It is likely that there will be a consensus on the reform bill since both entities were able to pass similar proposals. However, since the bill  does include a repeal of Obamacare’s individual-insurance mandate and delays some cuts and changes for at least another 12 months, it remains to be seen whether both sides will reach an agreement before the New Year.

Your income level and net worth will also dramatically affect how much this reform means to your real estate business. Some analysts predict that states with heavy tax burdens will see a “mass exodus” of high-income residents if these national rules go into effect since heavy state tax burdens will play a big role in determining how much the national legislation hurts high-earning taxpayers.


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