The new tax law, officially known as Tax Cuts and Jobs Act (TCJA), provides generally lower tax rates for many U.S. taxpayers, but how will the new tax laws affect the current and prospective homeowners?
Under the new tax rules
Because of provisions that benefit taxpayers like increased standard deduction and lower marginal tax rates, to offset the cost of these broad cuts, some provisions are curtailed that specifically benefit homeowners – these include mortgage interest and state and local taxes. With the passage of the TCJA, the after-tax benefit of homeownership has lessened. At the same time, the new tax rules level the playing field between renters and homeowners tax-wise.
Keep in mind though that the tax changes impact each household differently. There are a lot of variables for individual homeowners and prospective homeowners. With so many changes to many of the inputs to your tax return, whether you benefit from the new tax rules and to what degree will depend on your location, how much debt you currently owe, what type of debt, how much you/your household make, and who makes up your household.
Tax Rate Reductions
The tax rate schedule retains seven brackets with slightly lower marginal rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
Mortgage Interest Deduction
The new tax law reduces the limit on deductible mortgage debt to $750,000 for newly issued mortgages. Before, homeowners could deduct interest on mortgages up to $1 million. Current loans of up to $1 million are grandfathered and are not subject to the new $750,000 cap. Neither limit is indexed for inflation.
Existing homeowners may refinance mortgage debts existing on 12/14/17 up to $1 million and still deduct the interest, so long as the new loan does not exceed the amount of the mortgage being refinanced.
Interest remains deductible on second homes but subject to the $1 million / $750,000 limits.
Deduction for State and Local Taxes
The new tax law allows an itemized deduction of up to $10,000 for the total of property, state income, and local taxes. This $10,000 cap applies to both single and married filers and is not indexed for inflation.
The new tax law has almost doubled the standard deduction, reducing the value of the mortgage interest and property tax deductions as tax incentives for homeownership. There will be a standard deduction of $12,000 for single individuals and $24,000 for joint returns. The new standard deduction is indexed for inflation.
The Tax Policy Center estimated that the percent of tax filers claiming the mortgage interest deduction would fall from around 21% of all taxpayers to just 4%. This means there will be no tax differential between homeowners and renters.
Home Equity Loans
The new tax law repeals the deduction for interest paid on home equity loan through 2025. Interest is still deductible on home equity loans (or second mortgages) if the proceeds are used to substantially improve the residence. To differentiate between eligible for deduction and non-eligible; if you’re using your loan to buy furniture, the interest is not eligible for deduction. If you’re using it to upgrade your kitchen, the interest is eligible since it increases the value of your home.
Capital Gains and Mortgage Credit Certificates
Taxpayers continue to be eligible to exclude $250,000 in gains for single filers and $500,000 in gains for joint filers if they sell their home at a profit. You can avoid paying capital gains on your home sale as long as you’ve lived in the house for at least two of the five years prior to selling.
Mortgage Credit Certificates or MCC allows first time home buyers to exchange a portion of their mortgage interest into a tax credit. This has been retained in the final bill.
If you are buying a new home under the new tax rules
If you are buying a new home, the new tax law will be the least of your concern if you have other objectives in choosing to own a house. However, since you could lose deductions for both your mortgage and property taxes, becoming a homeowner in 2018 and beyond could be more costly than it would have been had you bought a home last year.
Despite the changes, many taxpayers could see a rise in their after-tax income despite the elimination of these deductions. Should that be your case, those extra dollars could make it easier to save money toward a down payment. After all, the decision to buy a home doesn’t really revolve around tax calculations. It is meeting your real estate needs, improving the quality of life, and building wealth through the growth in your equity that would lead you to homeownership.