President Trump finally announced his Tax Reform Plan on November 2. The reduction of corporate tax rates and the lowering of individual tax brackets for high income earners has received the most attention from the media. But those of us in real estate were anxious to see if the president and Speaker Paul Ryan would follow through on all of their promises to change some sacred cow real estate provisions of the Tax Code.
Not long after President Trump took office, I wrote of some of the potential changes that many experts expected would be included in the Trump plan (see post HERE) regarding real estate. The experts weren’t far off. I don’t want to discuss the entire tax reform plan, only those provisions dealing with real estate. The most obvious provision is the mortgage interest deduction. From the beginning, President Trump said that he would not eliminate this popular deduction. Instead of eliminating the deduction, the Trump plan preserves the deduction, but it reduces the cap for married couples for mortgages worth $1,000,000 to $500,000. This reduction would apply to new mortgages only. Existing mortgages would be exempt. I suppose the intent was to allow homeowners to keep a tax break that they had when they bought a new home but the effect is that the cap reduction will be a disincentive to home buyers, particularly in areas where home costs are high.
The mortgage interest deduction will not apply to second or vacation homes. Many will argue that this eliminates a tax break on the wealthy. But the elimination of this deduction has potential to greatly affect the real estate market. It will put numerous people out of the second home market completely which will depress property values in many places. Second-home communities (think beach towns and mountain communities) will suffer economically with out the seasonal influx of second home/vacation home owners.
The Trump plan makes it more difficult for homeowners to get the capital gains exemption on their primary residence. Existing law allows you to exempt up to $250,000 of capital gains ($500,000 for married couples filing jointly) if you have lived in your primary residence for 2 of the past 5 years. The Trump plan will lengthen the time requirement to 5 out of the previous 8 years. This will provide many homeowners another disincentive from moving further depressing the re-sale market.
The proposed Trump plan retains the deduction for state and local property taxes up to $10,000 but eliminates the deduction for state and local sales and income taxes. Not only will residents of high tax states be hurt by the elimination of the latter deduction, so will owners of income producing property all over the country.
The Trump plan eliminates the deduction for moving expenses. This deduction only applies if you are required to move for a new job or a transfer for an existing job. While the elimination of this deduction is unlikely to affect most peoples’ decision whether to sell their home and move, it does make the cost of a move more costly and could affect a buyer’s decision on how much to spend on the new purchase, or whether to purchase at all.
The Low Income Housing Tax Credit has been retained under the new plan. Unfortunately, other changes in the Trump plan effectively gut the LIHTC. Nearly half the new low income housing development is done with private activity bonds. These tax exempt municipal bonds are scrapped under the Trump plan. The other half of low income housing development is financed on the tax credit program. They will become more expensive as tax rates go down because tax credits will worth less. Some experts predict that over 80,000 fewer new affordable housing units will be constructed next year if the Trump plan is passed.
The president made no changes to 1031 exchanges or in changing the rules regarding deductability of capital expenditures which many experts had predicted would be part of tax reform. However, as the real estate president, maybe we should not be surprised as Mr. Trump has used both provisions in his years as a real estate entrepreneur.
The real estate president has made some surprising tax reform proposals that could have some very adverse affect to the housing market. If passed, housing prices could fall significantly while not immediately attracting new buyers.
There will be a long battle in Congress over tax reform. Despite President Trump’s and Speaker Ryan’s desire to pass the legislation before the end of the year, we are likely to see lengthy debate and multiple amendments. Already, the Senate has announced its own plan which keeps the mortgage interest deduction and the deduction for state and local income taxes. It is not only unlikely that tax reform will achieve bi-partisan support, but it is obvious that it dos not have full Republican support. So, as changes are made, it will be interesting for us to see how the provisions pertaining to real estate continue to evolve.