The Tax Change Wild Card

Will the Federal Reserve’s pause on interest rates matter if households get hit on deductions?
tax puzzle

© Karen Roach -

Let’s start with the good news. The Federal Reserve won’t aggressively raise interest rates this year. Instead of four rate hikes in 2019, as was widely assumed a few months ago, the Fed is likely to raise its short-term rate just once. This shift has quickly led to a measurable fall in the rate on 30-year fixed-rate mortgages, from 5 percent in early December to 4.5 percent a month later. Why the change?

First, the housing market is softening. Sales haven’t kept up with job gains and population growth. Even inventories, which have been tight for years, are starting to rise.

Second, the inflation threat is receding. Although consumer price inflation hit a seven-year high of 2.4 percent last year, there is little sign it will be a factor in 2019. In fact, the Fed expects inflation to drop below 2 percent, As a result, the outlook for home sales improves. Look for an additional 200,000 sales for every 50-basis-point reduction in the cost of money, based on historical data.

But a new factor could prove to be a wild card: the limit on mortgage and property tax deductions enacted in 2017. While 95 percent of homeowners will be able to fully deduct their mortgage interest and taxes under the changes, others will not because they’ll no longer itemize their deductions, which makes homeownership more costly. So lower interest rates may have less power to spur sales.

For real estate investors, the mortgage interest deduction and property taxes remain fully deductible—as business expenses. Certainly, homeowners facing this unfair tax hit could act like investors by renting out their house (after proper disclosures to their mortgage lender), deducting their mortgage interest and property taxes as business expenses, and moving into a comparable rental home.

But our data shows most people want to live in the home they own. Shouldn’t homeowners get the same tax benefits as investors? In the year ahead, it’s an issue to be raised with lawmakers.