2018 Tax Update: Changes Affecting Tax Incentives of Owning a Home
- Changes to MID (2:15)
- Limits on state, local tax deductions (6:37)
- Curtailment of casualty deduction (10:04)
- Curtailment of moving expense deduction (11:36)
- Retention of capital gains exclusion on home sale proceeds (13:44)
Transcript and Slideshow
Download the slideshow (PDF: 1.82 MB)
EML: (lower third - Evan M. Liddiard, CPA (first line) Director of Federal Tax Policy, National Association of REALTORS® (second line)
My name is Evan Liddiard of the National Association of REALTORS® and I would like to welcome you to our video series on what you need to know about the new tax law. In this segment, we are going to cover the changes affecting the tax incentives of owning a home for individuals and families filing tax returns for 2018.
Joining me is Peter Baker of the Business Planning Group. Peter has decades of experience helping REALTORS® and real estate businesses with their taxes.
PB: (lower third - Peter G. Baker, CPA (first line) Founder of Business Planning Group, Washington, DC (second line)
Happy to be back, Evan.
In the prior video, we talked about the good news for most American tax filers that comes from the fact that last year's Tax Cuts and Jobs Act significantly lowered the income tax rates. We also mentioned the mixed news that the standard deduction has nearly doubled but that the personal and dependency exemptions have gone away.
However, for those with kids age 16 and under, the child credit has been doubled to $2,000, with higher-income families able to claim it. Overall, the net effect of these changes is very positive for most individuals and families.
In this segment, though, we are going to cover some changes that are not as welcome, because they repealed tax benefits that millions have relied on, in some cases, for decades. Most of these changes relate to owning a home.
For more than 100 years, since the modern income tax system was created in 1913, the law has incentivized Americans to purchase a home by allowing a deduction for mortgage interest paid when you borrow to buy a home, and also by allowing an unlimited deduction for property taxes paid on that home.
The tax law still allows these homeownership deductions, but starting in 2018, there are some new restrictions on both the mortgage interest and the property tax that will impact some homeowners.
These changes will affect people in different ways - some will find them a big problem, while many, partly due to the increased standard deduction, won't notice them at all.
[Slide 1 - Changes to the Mortgage Interest Deduction]
We will begin by covering the changes to the mortgage interest deduction. These can be confusing but our goal is to bring you clarity.
Since 1987, there has been a $1 million limit on the amount of mortgage debt that could be borrowed for purposes of having the interest be deductible. For example, if someone borrowed $1.3 million on a mortgage to buy a home, only the interest on the first $1 million was deductible.
The new tax law has now lowered that $1 million limit to $750,000, but only for new mortgages taken out after December 14, 2017. For mortgage loans existing on that date, the limit is still $1 million.
And interest on these "grandfathered" mortgages will remain deductible as long as the homeowner keeps the loan. Such loans can even be refinanced with the deduction retained, so long as the original term of the loan and the balance owed on the date of refinancing is not increased.
There is also some good news on the interest deduction for second homes. The House version of the tax reform bill removed the deduction for second homes altogether. But the final tax act keeps it intact.
However, for new loans after December 14, 2017, the total amount borrowed for both the main residence and the second home cannot exceed $750,000. Grandfathered loans that existed on that date, however, are still deductible up to $1 million for both the main home and the second home combined.
We have one final change to discuss on deducting mortgage interest. There has been a great deal of confusion about whether interest on home equity loans, home equity lines of credit, or second mortgages can be deducted. The new law now prohibits the deduction of such interest, but only if the proceeds of the loan are used for personal purposes, such vacations, cars, higher education expenses, or paying off other debt.
However, if the money from such a loan is or was used to pay for substantial improvements on the home against which the money was borrowed, then the interest remains deductible. The same $750,000 total limits apply for new home equity loans taken out after last December 14.
If you have a home equity or second mortgage loan that was in existence on December 14, the limit is still $1 million, but all your loans, first, second, and/or home equity, have to be under these limits. And remember, the proceeds of all loans had to be used to purchase, construct, or substantially improve the home in order for the interest to be deductible.
Peter, how big a deal are these changes going to be for your clients here in the Washington, DC area?
For most of my clients, who are not selling their home or buying another one right now, there won't be much impact at all due to the grandfathering feature for existing loans.
However, if any taxpayers want to purchase a second home or move up to a larger home, this new $750,000 cap can be a limiting factor. Washington is a high-cost area for homes, and many residents have homes worth much more than this cap. In other parts of the U.S., though, the lower mortgage ceiling will affect very few people because houses, on average, in those areas are worth far less than the limit.
Lastly, in cases where home equity loans are used for personal purposes, and not to fix up their home; not being able to deduct this interest has a negative impact to their tax and spending plan and is an effective increase to the cost of borrowing.
[Slide 2 - Changes to the SALT Deduction]
The next big item to discuss for homeowners is the new limit on the deduction for state and local taxes, which is often referred to as SALT. This change has received a lot of attention and it has been very controversial. One of the biggest expenses facing homeowners is the property tax they must pay, and up until this year, this and all other state and local taxes have been deductible without limit for itemizers.
Starting in 2018, however, every individual and family faces a maximum deduction for all of their state and local taxes of $10,000. Please note that single individuals and married people face the same $10,000 limit, which means that this provision brings a nasty marriage penalty into the picture.
The $10,000 limit is for the total of all state and local taxes. For those living in states that have an income tax, which is all but seven, this means that total deduction for property and income tax for the single filer or the family cannot exceed $10,000. Those in states without an income tax are allowed to deduct sales tax instead, so this is what would be added to property taxes to determine the total.
As is the case with the lower cap on mortgages, this new $10,000 SALT limit is not going to be a big problem everywhere. In many parts of the nation, property and income taxes are relatively low, and even two-earner couples will not be shelling out more than $10 grand in total in state and local taxes.
The $10,000 limit is not indexed for inflation, however, and over time, its impact will grow as state taxes naturally rise due to the higher home values and higher costs of living.
There are many places, particularly on the coasts and in the Northeast and some in the Great Lakes area, where a very high percentage of homeowners are going to find their state and local tax deduction limited. In a handful of these states, the property tax on a median valued home by itself takes up more than half of the limit, before income taxes are even considered.
Also, please note that there will be at least some people in every state who will feel the pinch of this limit on the SALT deduction. Of course, those with higher-valued homes and who also earn a lot of income will be hit the hardest.
As bad as this new limit might be, it might have been far worse. The original bill in the House had a $10,000 limit on property taxes but did not allow any income tax to be deductible. And the first Senate bill disallowed the state and local tax deduction altogether.
Evan, I think we should emphasize here that neither the new SALT cap of $10,000, nor the new limit on the mortgage interest deduction, affect landlords of rental property. Interest expense and property taxes on such rental real estate as well as other trade or businesses will continue to be fully deductible to the owners. So in this sense, the tax code pendulum has shifted between homeowners versus renters.
Now, let's spend a couple of minutes talking about a few other changes that will not affect as many homeowners as the ones we just covered, but that still could really take a tax bite out of those who are hit by them.
[Slide 3 - Other Changes]
The first one of these is the curtailment of the casualty loss deduction. This provision has been in the tax law for a long time and was designed to assist those who found themselves victims to losses due to fire, storm, theft, or other sudden and expected events that cost them money.
Under the prior law, someone who suffered a casualty loss could take an itemized deduction for the portion of the loss that exceeded any insurance proceeds and to the extent that the loss was greater than 10 percent of their income. This could make a tremendous difference for those with large losses or low incomes or both.
But last year's tax bill repealed the casualty loss deduction with one major exception - it is still available for those who suffer casualty losses attributable to a presidentially-declared disaster.
Peter, how big of a change is this?
Of course, most of us who are lucky enough to not experience a casualty loss will not even miss this deduction. But unfortunately, those who have a fire or other loss occur which happens to not be the result of a widespread disaster, could now be doubly unlucky by the repeal of this deduction.
Also, under the old law, because this casualty loss deduction was designed to help those most with the largest losses and/or the lowest incomes, these are the people who will be most hurt if their casualty happens outside a disaster zone.
The second noteworthy change in this section is the almost complete repeal of the moving expense deduction. Many clients of REALTORS® are among the tens of millions of Americans who move each year.
Under the previous tax law, many of the expenses of moving were deductible if the new place of work was at least 50 miles farther from the former home than was the former workplace. If this test were met, the reasonable expenses of moving household goods and personal effects from the old to the new residence was deductible, along with the cost of traveling.
The new law repealed this deduction for everyone except members of the Armed Forces on active duty that move pursuant to a military order incident to a permanent change of duty station.
Losing this deduction is going to be tough on a lot of people. But it is even going to be worse than it might seem for many of them. This is because this deduction is not just for itemizers. Rather, it is known as an above-the-line deduction, meaning that everyone can take it whether they itemize or not.
This is key because in many cases, the employer reimburses the employee for these expenses when they are job-related. And the dollars involved can be quite large, especially for longer distance moves and when there is a family. But as you may or may not know, these reimbursed amounts are often included in the employee's Form W-2 as taxable income.
When, under the old law, the employee is able to claim the moving expense deduction, the income and deduction often result in a wash with no additional tax. But this will no longer be true.
Instead, employers who reimburse their workers for moves will have to either leave the employee responsible for the increased tax on move allowance, or will have to provide extra cash for them to pay the tax on the reimbursement amount, and possible gross that amount up to cover tax on the extra cash to pay the tax. And so on.
[Slide 20 - Exclusion of Gain on Sale of Principal Residence]
Finally, let us end this section on a high note. When the original versions of the tax reform bill were passed, they both included a provision that would have greatly limited the availability of the beloved tax provision that allows single sellers of a principal residence to exclude from tax up to $250,000 in capital gain on the sale of a home, and up to $500,000 for a joint return.
The provision said that instead of a seller being eligible for the exclusion after owning and living in the home for 2 of the prior 5 years, it would now be 5 of the prior 8 years. NAR research indicates that this change could affect as many as 20% of home owners.
Fortunately, with some strong lobbying by NAR and other groups, this change was eliminated and the final bill kept the prior 2-out-of-5-year rule for exempting the capital gain on the sale of a home. This was a huge win for REALTORS® and for homeowners.
It is great to see that at least one of the major tax incentives for owning a home came out of this new tax act unscathed.
This concludes this section of our video series. In the next one, we are going to discuss how the new tax law treats the business of being a real estate professional. And here we will have a big surprise for many of you - a brand-new deduction that can make a serious dent in your tax bill. Thanks for watching.