In the aftermath of the federal tax bill, we’ve seen a number of competing narratives emerge as to how this new tax regime will impact homeowners in expensive places like California. While there are many reasons for homeowners in expensive places to be anxious about the changes, when it comes to their monthly budget or the price of their home, they shouldn’t expect much of a change. At least not until many of the individual tax breaks expire in 2025.
Evaluating Housing Costs for Existing Homeowners
In terms of negatives, the tax bill certainly has many.
- For one, homeowners are losing some of the mortgage interest that they can deduct on their taxes. Instead of being able to deduct the interest on your first $1M of mortgage, now only the first $750,000 is eligible. Evidently, this impacts those that have mortgages larger than $750,000 (disproportionally dual-income families that have bought homes in the last 10 years). For those that have mortgage amounts above $750,000, the maximum tax increase that this could create is somewhere in the vicinity of $2,500 per year.
- More importantly, a limit is being introduced on the amount of property taxes and state taxes a homeowner can deduct on their federal taxes. Now, only a maximum of $10,000 can be deducted per household, whereas one could deduct as much as one wanted before. This impacts almost all new homeowners in expensive places, and many older homeowners as well. This particular tax increase could be much higher, reaching above $15,000 per year for those high-income households who own expensive homes.
But that’s not the whole story. To counteract some of these effects, the individual tax brackets and tax rates are changing to give tax breaks to high-income families. If you include these effects, the effects look considerably more rosy for high-income families who own homes.
Further, the bill’s primary purpose, to decrease taxes on businesses, disproportionally impacts those families with high-incomes. For the top 20% of income earners, over 50% of their net worth is tied up in stocks and private businesses vs. 25% for the typical family. Decreasing taxes on business profits will therefore mean more money in the pockets of high-income households.
Summary: Not many short-term impacts for existing high-income homeowners. The tax bracket changes offset most of the new limits on mortgage interest and property tax deductibility.
Evaluating the Impacts for New Homeowners
On the negative side, the tax bill significantly changes the incentives for purchasing a home in the first place. That’s because while only homeowners suffer the loss of the mortgage interest and property tax deductibility, everyone (homeowners and non-homeowners) get the benefits of lower tax rates. At Landed, we’ve adjusted our homeowner calculator to show that becoming a homeowner to take advantage of tax breaks is no longer a strong reason to buy a home. But tax advantages are just one reason among many that families choose to buy homes.
On the positive side, high-income renters will find themselves with more after-tax income. They might use this extra income to successfully save for a down payment, increasing the demand for homes. This extra income might also put upward pressure on rents, encouraging people to think about purchasing a home. Tax reform might promote growth in the economy, leading to higher wages and more demand for homes.
Summary: Anyone who tells you they know exactly how this tax bill will impact housing purchases is fooling themselves. The housing market is an extremely complex system, and it’s likely that the net effect of the bill on the housing market is neutral.
Evaluating the Impacts on Housing Prices
In cities where housing prices are high, they stay that way largely because there is a significant mismatch between the supply of new housing and the demand for new housing. Another way of saying this is to say that in San Francisco, between 2010 and 2015, over 6 jobs were created for every 1 new unit of housing. As a result, we have come to the situation where over 85% of households rent (in more and more cramped apartments) compared to only 15% of households that have been able to strike out and purchase property. See this blog post on misunderstood homeownership rates.
This bill makes owning and renting out property more profitable, and it does not increase existing homeowners desire to sell. In fact, if anything, it makes it slightly less likely for existing homeowners to sell because new mortgage interest will only be deductible up to $750K of mortgage amount, as opposed to $1M for existing mortgages -- existing mortgage interest deduction is grandfathered in as a part of the new tax bill. Moreover, this bill doesn’t make it any easier to build new housing. Therefore, the biggest issue in hot real estate markets (not enough supply) will remain as such.
Again, as discussed, the loss of tax incentives might somewhat decrease demand for new home purchases, but that decrease in demand needs to be weighed against the increased demand from renters with more cash, more jobs and general demographic changes (more millennials entering the homebuying stage of life).
Summary: Housing prices are set by supply and demand. Housing prices are currently high because there is extremely limited supply for all the people who want to buy a home. This bill does nothing to change the supply side of the problem, and will have a limited effect on demand. It is more likely than not that the status quo continues for housing markets in expensive places.