Tax Law Changes: How does it impact buying a home?
The Republican tax law changes passed in December included specific changes that affect homeowners and broad changes that could affect home prices and affordability for buyers. Here’s what you need to know about how the tax bill might affect you if you’re thinking about buying a home.
You Probably Won’t Deduct Mortgage Interest or Property Taxes
Homebuyers can no longer assume their mortgage interest will be tax deductible when calculating their budgets. Because the standard deduction for individual taxpayers jumped from $6,350 to $12,000 and the standard deduction for married taxpayers filing jointly jumped from $12,000 to $24,000, many homeowners will no longer come out ahead by itemizing. Instead, they will take the standard deduction, which means they won’t take a deduction for their mortgage interest.
The Tax Policy Center estimates that only 4% of taxpayers will claim the mortgage interest deduction under the new tax law. Most of those taxpayers will be in the top 20%, meaning those who earn about $150,000 or more per year.
Homebuyers also shouldn’t plan on deducting their property taxes. Homeowners can now only deduct a maximum of $10,000 in combined state and local taxes (SALT), including property taxes. Colorado’s property taxes and state income taxes are relatively low, so this change has a smaller effect on Coloradans than, say, Californians or New Yorkers. Still, in Colorado, about 26% to 40% of taxpayers claimed a SALT deduction (the percentage varies by congressional district), and the vast majority who claimed it earned less than $200,000 per year. Fewer will claim it under the new tax law.
The good news is that if you’re a small business owner who is eligible for the home office deduction, you can still take a partial deduction for mortgage interest and property taxes as a home office expense. Any tax software program geared toward small business owners explains this is simple steps. Basically, here’s how it works: if 15% of your home’s square footage is dedicated regularly and exclusively to your home office and it’s your principal place of business, you can deduct 15% of your mortgage interest and property taxes on form 8829.
You Might Take Out a Smaller Mortgage
The home mortgage interest deduction used to be available on mortgage debt of up to $1 million ($500,000 for married homeowners filing separately). Those who already had such a mortgage in place when the tax law went into effect retain that deduction. Those who buy homes after the tax law went into effect can only take the deduction on mortgage debt of up to $750,000.
Few homebuyers will be affected by this change. About 6% of homes nationwide had a mortgage balance of more than $500,000 in 2013–15 according to federal Home Mortgage Disclosure Act data reported by the United for Homes campaign for affordable housing. In Colorado, that percentage is just 3.7%.
In December, the median sales price in Denver was $415,000, and the average sales price was $485,000, according to the Denver Metro Association of Realtors. While Denver’s luxury real estate market is strong, it’s not large: fewer than 10% of Denver’s listings in December were priced at $750,000 or higher.
You Might Have More Cash for a Home
If the tax bill cuts your household’s taxes, you might have an easier time saving up a down payment and you might have more monthly cash flow to make mortgage payments. More money in your bank account means you might be able to purchase a more expensive home in 2018 through 2025 than you could have in 2017, or you might have an easier time qualifying if you were previously on the bubble. Denver’s low housing inventory, especially for entry-level to mid-range homes, means it will still be a seller’s market, though. That extra cash might get spent in bidding wars.
Tax rates and tax brackets are lower across the board now. The higher standard deductions mentioned earlier may help, as will the expanded child tax credit for households with children.
The loss of the personal exemption, however, offsets — and for some taxpayers eliminates — the benefit of the higher standard deduction. As a result, you might not have more cash to buy a home. A financial planner or CPA can help you figure out how the tax bill will change your tax liability.
You Might Pay a Higher Mortgage Rate
So far, the tax bill has been good for the economy. But could the tax cut be too good for the economy? The Federal Reserve said at its last meeting that it would likely implement three interest rate increases in 2018. If inflation of higher than 2% becomes a threat, interest rates could increase more or faster than expected. When the Fed increases interest rates, mortgage rates go up. Higher mortgage rates could cancel out the effect of having more cash to buy a home.
Your Home Equity Loan Will Cost More
If you’re planning to use a home equity loan for future renovations, be aware that you won’t be able to deduct the interest on your loan like before. The tax bill eliminated this tax break, making it effectively more expensive to take out a home equity loan. If interest rates increase, home equity loans will also be a more expensive way to borrow.
Final Thoughts
Ultimately, tax considerations play a small role in most people’s decisions to buy a home or continue to rent. Owning a home is about lifestyle, stability, independence, and accumulating wealth through home equity. Tax deductions related to home ownership are a perk, and they no doubt make home ownership more affordable for many households, but they aren’t the driving force behind home ownership. With all the changes from the GOP tax bill, you may not save because you’re a homeowner, but you might still have a lower tax bill overall that helps make home ownership more affordable — or you might not. It all depends on your individual situation.
