Buying a home? Here’s how the Tax Cuts and Jobs Act impacts you
Changes to home purchase and ownership tax deductions
- Tax-deductible mortgage debt is capped at $750,000
- State and local property, income and sales tax deductions are capped at $10,000
- Standard deduction is $12,000 for individuals and $24,000 for married couples
- Interest on home equity loans and lines is no longer tax deductible
Homeowners have long enjoyed substantial tax advantages allowing for mortgage interest, property tax and other costs to be written off their tax bills.
The Tax Cuts and Jobs Act signed into law December 2017 changes the tax implications of homeownership, reducing mortgage interest and state and local tax deductions while increasing the standard deduction and eliminating most home equity deductions altogether. The most far-reaching tax reform in decades, the law applies to the 2018 tax year and remains in effect through the end of 2025.
In the past, a number of households that were eligible for numerous tax deductions – such as interest deductions, charitable donations and medical expenses – found benefit through itemizing their taxes compared to the benefits of the old standard deduction. The new tax code shifted that benefit somewhat. Now, the new tax rule lowered deduction limits, eliminated other deductions, and put taxpayers into different territory.
Depending on your income and where you live, the new law may reduce or increase the cost of homeownership.
Mortgage interest and SALT
The tax reform introduces two major changes that directly affect the cost of buying a home: the reduced mortgage interest tax deduction and cap on state and local tax (SALT) deductions.
For households that choose to itemize their taxes, the law now limits tax-deductible mortgage debt to $750,000, down from the previous limit of $1 million. SALT deductions — which include state and local property, income and sales taxes — are limited to $10,000 per household. Under the old law, there was no cap on the SALT deduction.
The mortgage interest and SALT changes must be weighed against a new increase in the standard deduction. The individual standard deduction is now $12,000 — up from the previous $6,350 — and the standard deduction for married couples is now $24,000 — up from $12,700.
About 45 million taxpayers, roughly 30 percent, itemized their deductions under the previous tax code, according to 2015 IRS data, the most recent available. Meanwhile, a January 2018 report from the Urban Institute, a nonpartisan policy research organization, suggests that the new, higher standard deduction will further discourage itemizing, and those who do will see less benefit from it.
The January 2018 Economic and Housing Outlook released by Fannie Mae’s Economic & Strategic Research Group echoes this sentiment, predicting that the law will result in “substantially fewer” itemized returns.
“The Tax Act will create winners and losers in the housing market,” according to the Fannie Mae report. “While the individual tax cut should boost housing demand by increasing disposable household income, the tax bill reduces the incentive for homeownership.”
Taken together, these changes may impact purchase scenarios in several ways.
First-time homebuyers are impacted on several levels. Individuals in this group typically are renters ready to move into homeownership.
The Urban Institute report suggests that the tax change altered the landscape enough so that – for some at least – it now makes more financial sense to continue renting. That said, the study contends there are still benefits beyond the taxes that ownership brings, including a sense of stability, and broader choices in location and size.
The tax changes on first-time homebuyers should have a minimal impact overall, said Paul Risenhoover, senior loan officer at White Rock Mortgage. Millennials may balance out the markets. He noted the housing market can expect a boost from millennials — one of the largest generations in U.S. history — as they reach the peak homebuying ages of 25 to 40 years old.
“The millennials have waited to buy, but now they are starting,” Risenhoover said.
Buying a home in a mid-range price
Buyers shopping for homes worth less than $750,000 and those living in areas with low property, income or sales taxes may experience tax savings from the new law. Some households won’t see much change in their tax obligations. How significant the savings are will depend on your financial situation and location.
If your total mortgage interest and SALT deductions are lower than the new standard deduction, you will get a tax break.
Buying high-end and second homes
Those in the market for a mortgage worth more than $750,000 and those living in areas with high property, income or sales taxes will likely face an increased tax burden. High-cost markets often carry high property taxes as well — for example, large metros in New York and California — resulting in a double hit to eligible deductions.
The Fannie Mae report suggests that the increased tax burden on expensive properties could cause high-end housing prices to fall. This may benefit cash buyers or those taking out a smaller mortgage, but the reduced SALT deductions may offset any savings.
Owning more than one property will be more expensive for many, as well. If you buy a second home, the $750,000 limit on mortgage interest deductions applies to both mortgages combined.
Home sales and capital gains
If you have a home to sell, tax deductions on your profits are protected. The tax reform retains the capital gains tax exclusion of up to $250,000 for individuals and $500,000 for married couples for the sale of a property that has been your primary residence for two of the past five years.
Although there are no tax changes to profits from selling your home, if you have a high-value property, you may not be able to get as strong a sale price as you expected. Moreover, if you move to another high-end home or high-tax locality, you may end up paying more in taxes on your next mortgage.
Home equity considerations
Many homeowners use the equity in their home to finance debt consolidation, renovations or emergency expenses. The new tax changes eliminate mortgage interest deductions on most home equity loans and lines of credit. Previously, homeowners could deduct up to $100,000 in interest on home equity debt in addition to their primary mortgage interest deduction.
Certain home equity debt used for substantial improvements to your property may remain deductible, although the IRS has yet to clarify the law as of early February 2018. Although home equity loans are now costlier, they may still be an optimal strategy for homeowners to access cash.