Republican Tax Reform and Denver’s Housing Market
The proposed Republican tax reform legislation will have lasting effects on homeowners, homebuyers and housing in Denver and across the country. The US House and Senate each have their own versions of the bill, so let’s discuss some of the primary provisions.
If they get the votes for it, which still isn’t certain, the final bill will likely be a combination of the House and Senate proposals. GOP leaders have set a goal to pass the bill by the end of the year, and put the new law into effect by January (yes, next month!).
Here are some of the changes they’ve proposed that will affect homeowners and real estate:
Mortgage Interest Deduction Cap (MID)
The bill passed by the House in early November lowers the cap on the loan amount for deductible mortgage interest, from $1M to $500,000. With a median home price of $530K in DC, this will affect a significant number of potential homebuyers in the higher price ranges (about $550K and above, if you assume a 10% down payment would give a $500K mortgage). Limiting this deduction will effectively increase the cost of owning a home in the higher price ranges.
It’s important here to note: this provision only affects new buyers. A grandfather clause in the House bill would allow current homeowners to keep their full deduction. This was probably meant to be fair to current homeowners who made their home purchase factoring in the deduction. But, by grandfathering the provision, it may encourage current owners who benefit from it to stay in their homes longer. I predict this will exacerbate the inventory shortage we’ve felt since 2011, especially in the crucial buy-up range of $600-$1M.
The Senate’s proposed language would not touch the MID — instead it focuses solely on the property tax deduction.
Property Tax Deduction
The House bill caps deductible property taxes at $10K per year. The Senate’s version eliminates the property tax deduction altogether (but as mentioned, leaves the MID alone). With a large number of homes in DC worth over $1M, many homeowners will be affected by the $10K cap in the House bill, and all homeowners taxes will be affected by the Senate’s version. Homeowners in other areas of the country with high real estate values — especially the Northeast and coastal California — will feel these effects more than homeowners in the Heartland, where property values are lower.
Standard Deduction Increase
Another potentially huge change for most income earners is the proposed adjustment of the Standard Deduction. Both the House and Senate versions of the tax bill propose increasing the amount by more than double, from $11,700 to 24,000.
Presumably this is an effort to simplify the tax code, since fewer people will itemize on their returns with a higher standard deduction amount. But it would also significantly reduce the number of taxpayers who use the two main deductions which go along with homeownership–the mortgage interest and property tax deduction. This could make the prospect of homeownership generally less attractive, and may encourage renting over buying.
Are GOP Tax Reforms Good Ideas for Housing?
The mortgage interest deduction has been on the chopping block for a while. Many economists consider it bad policy, and it didn’t originate as an intentional policy move for housing — in the early 1900s it just used to be that any and all interest was deductible. Though it can be seen as giving those who have the means to purchase a home an unfair advantage over renters who can’t afford a down payment or closing costs, it has played an encouraging role for homeownership overall.
The property tax deduction makes sense on principle, and it poses greater risk to home values if eliminated. Why should we pay taxes on money we’re already paying to the state? This popular deduction has a sound logic behind it. And you better believe that corporations deduct their property taxes.
Property taxes are based on value assessments, which ideally tend to go up — so the property tax deduction plays a valuable role in keeping homeownership affordable. The loss of this deduction will increase the cost of owning in a more fundamental way than the loss of the MID, which decreases over time as one pays down the loan.
How Will Republican Tax Reform Affect Denver Real Estate?
There’s more to this tax reform with regards to housing: the legislation impacts the mortgage interest deduction on second homes, the time frames on capital gains exemptions from real estate sales, and there are a few other provisions that will impact housing. Such significant changes are bound to create ripple effects on our economy, both seen and unseen.
It stands to reason that since these at-risk housing deductions are baked into real estate values in DC and across the country, eliminating them will reduce values and appreciation levels (again, with stronger effects along the coasts). Many Americans hold most of their wealth in their primary home and, as we learned in 2008, the housing industry plays an essential role in our economy. So this legislation will likely have broad-reaching effects on the local and national housing market.
That said, tax reform isn’t necessarily a bad idea — and perhaps it would be a good thing to encourage policies that reduce dependency on the housing industry for the nation’s economic health.
Unfortunately, since Republicans in Congress seem determined to push this legislation through quickly, not enough consideration has been given and very little research has been done on the effects these changes will have on our nation’s housing and, as a result, the national economy. Sadly the most detailed numbers I could find were from Trulia and the National Association of Realtors, which are of course not independent sources. Though it’s hard to find any analyses that focus specifically on this bill as it affects housing, nearly every writeup agrees that it doesn’t truly benefit middle and lower income earners over time.