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How Tax Reform Could Affect U.S. Homeownership

Will President Trump’s tax reform proposal put a major dent in the housing market? Some experts say by doubling the standard deduction, the mortgage interest deduction will lose relevance because taxpayers won’t bother to itemize, and that will, in turn, discourage people from buying homes. But are tax savings the primary reason people buy real estate?

The Tax Proposal

The tax proposal would double the current standard deduction from about $6,000 to $12,000 for single filers, and $24,000 for couples. The mortgage interest deduction, or MID, would remain but state and local income along with property tax deductions would disappear. Or, as Republican lawmakers have recently discussed, homeowners may get a choice between the MID and the property tax deduction. But they wouldn’t get both.

In an article by Fortune it cites an analysis by the Tax Policy Center of an earlier but similar tax proposal. Based on that version, it estimates that 84 percent of the people who currently itemize their deductions would take the standard deduction instead, if it were double the amount that it is right now. It also predicts even more people would choose not to itemize if they lose the state and local tax deductions.

The article surmises that without these tax benefits the after-tax cost of homeownership will increase, and that many people will find renting is more affordable than homeownership. If people already own a home, they may decide they can’t afford to “trade up” — both of which would add another burden on an already slow housing market.

The National Association of Realtors (NAR) agrees. NAR believes President Trump’s proposal will result in “a tax increase for millions of middle-class homeowners.” NAR President William Brown said in a press release, “This proposal recommends a backdoor elimination of the mortgage interest deduction for all but the top 5 percent who would still itemize their deductions.” He said, “There’s a reason our nation has incentivized homeownership in the tax code for over a century. It works, and helps make homeownership more affordable for middle-class families.”

The National Association of Homebuilders was also on that side of the fence until recently. The trade group had been strongly opposed to a reform plan that would marginalize the MID but the day before the writing of this podcast, it did an about-face on that stance. It’s now embracing a creativity and flexibility in coming up with a reform plan and would support one that shifts away from the MID as long as lawmakers include a “homeowners tax credit.” However, wording for such a credit has not made an appearance yet in the proposal.

Building Wealth with Homeownership

But, what really motivates people to buy homes? Is it the mortgage interest deduction when interest rates are so low? The deduction may have made more sense back in the days when interest rates were much higher and for people who’ve paid off their mortgage or paid cash for their homes, it’s irrelevant.

That’s not to say that kind of change wouldn’t affect some people. It could hit people in states with high home prices and high property taxes, like California, New York, and New Jersey. So, it’s likely to put a dent in tax savings for some people, but to what extent?

Director of the University of Southern California’s Lusk Center for Real Estate, Richard Green was cited by CNBC as saying that the mortgage interest deduction encourages people to buy bigger homes, but he says, “Does it flip the switch between buying and renting? Maybe half a percent in homeownership, very little.” He also points out that Canada and Australia have high homeownership rates, and no mortgage interest deduction.

Co-director of the Housing Finance Policy Center at Urban Institute, Laurie Goodman, appears to agree with Green. She was cited by CNBC saying, “I think people buy homes because it represents security and a way to build wealth and a sense of stability.” She doesn’t think the mortgage interest deduction plays a large role in a home-buying decision.

That sounds reasonable to me. I think the mortgage interest deduction is icing on the cake. The true benefit of homeownership is having control over your monthly expenses. If you have a fixed-rate loan, you don’t have to worry about the landlord suddenly raising the rent, and at least some of the monthly payment is going toward equity in the home, which will accumulate over time.

There are other benefits as well, including the ability to customize your home, or have pets. You can do whatever you want with your own home, without permission from a landlord.

Landlords vs. Homeowners

As for how the proposal will affect rental properties, Fortune writes that there isn’t much change, so far, in what landlords would be able to deduct. Property owners would still be able to deduct financing costs along with state and local property taxes, maintenance costs, and depreciation. These expenses are treated differently for rental properties because they are counted against rental income. One “added” benefit however, could be a reduced tax rate of 25 percent for pass-through entities like LLCs, which are common in the real estate industry.

That is all good news for real estate investors, but as Fortune points out — should homeowners be treated differently than rental property owners? There are other aspects to the tax proposal that are supposed to benefit the individual taxpayer. According to the president, “The biggest winners will be the everyday American workers as jobs start pouring into our country, as companies start competing for American labor, and as wages start going up at levels that you haven’t seen in many years.”

That’s based on the idea that by reducing the corporate tax rate from 35 percent to just 20 percent businesses will pump more money into their operations and hire more people, at higher wages. Those people will then spend more money, and stimulate the economy. Critics say that’s all speculative. They say any break in the chain will put money in someone else’s pocket and not those of middle-class workers.

Individual taxpayers would also get reduced tax rates, but the savings won’t be monumental. The Tax Policy Institute says the average middle-class taxpayer would save an additional $1,000 a year. According to economic advisor Gary Cohn, it’s enough to renovate a kitchen, buy a new car, or take the family on a vacation. His tweet brought on a social media backlash however, by people who wanted to know where they could buy a car or renovate a kitchen for $1,000.

So, the tax reform plan is still a work in progress. At the present time, Republican Senator Rand Paul from Kentucky is not impressed. He commented on Twitter, “This is a GOP plan? I hope the final details are better than this.”

This article was originally published October 6th, 2017 on the Real Wealth Network.

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Kathy Fettke is the founder and co-CEO of Real Wealth Network. She can be reached at kathy@realwealthnetwork.com.