What Real Estate Agents Need to Know About the Tax Law
Jacqueline Kyo Thomas
In late 2017, a new tax bill was introduced and signed into law. This new tax law threatens to upend the real estate market as we know it. Sounds a little dramatic, huh? It all depends on how you look at it. As a real estate developer or investor, the new tax law is good news. But if you’re a real estate agent or a house hunter, the outlook may be less sunny.
As a Massachusetts real estate agent, what do you need to know about the new tax law and how it affects homeowners?
Federal tax laws are often complicated and multi-layered, not to mention boring and packed full of legalese. If scouring through the tax laws isn’t your favorite way to spend a Saturday afternoon, check out this quick rundown to learn what you need to know about the new tax law.
Originally presented as the Tax Cuts and Jobs Act, Public Law no. 115-97 (now known as "the Act") amends the previous tax code of 1986. The tax bill was signed into law by President Trump on December 22, 2017. Its aim is to reduce the tax rate for both businesses and individuals. However, by doing so, the tax bill also limits or eliminates many popular deductions.
If you’ve heard of this tax bill before, you’ve probably seen the “end is near” signs, too. There’s a lot of debate on how this new tax law will affect real estate agents in particular. Some experts think that it will dramatically and negatively impact the listing prices for new homes (affecting house hunters) and also detract from current values (affecting homeowners). However, others suggest that current homeowners have no reason to worry because the new tax law will only affect new home purchases.
Confused? Let’s break it down.
Here's how the new tax law will affect both homeowners and home buyers:
Perhaps the biggest benefactors of the new tax law are “pass through” business owners. In the new law, there are significant tax cuts for business people, such as real estate investors and developers.
The term "pass through" business indicates partnerships or limited liability companies where the business entity itself doesn't pay corporate tax directly. Instead, the business’ owners pay tax on their individual earnings.
The tax law provides for a whopping 20% deduction for “pass through” business owners. The 20% deduction does come with some limits, though: it cannot exceed either either 50% of W2 wages paid, or 25% of wages plus 2.5% of the value of capital assets (like, you guessed it, real estate).
Because “pass through” business owners will enjoy a huge incentive when purchasing real estate, experts expect to see many more of these entities pop up in response to the new bill.
Who exactly is eligible for this deduction? It's sort of complicated. For certain service providers, like accountents or attorneys, this new deduction will be available to owners of pass-through entities who make up to the income maximum of $207,500 for individuals and $415,000 for couples. For other businesses (like real estate investment firms), the deduction is available to any pass through entity regardless of income.
While the new tax law might be great for real estate investors, things are less cheery for many homeowners. Any home buyer who plans to purchase a home for over $750,000 will likely see higher tax bills under the new tax law.
Why? Because the mortgage interest deduction limit has been lowered. Under the old tax code, home buyers were able to deduct interest on a mortgage of up to $1 million. Under the new tax law the deduction is now limited at $750,000, and this new limit applies to mortgages on second homes, too.
How does the reduced mortgage interest deduction affect Massachusetts homebuyers?
Real estate is more expensive here in Massachusetts, with almost two million homes valued at $1 million or more. In Massachusetts, the median home listing price is $415,000 which is more than 60% higher than the nationwide median of $254,000.
While it’s true that this new bill won't affect every home buyer, it will definitely affect those who are looking to buy in the more expensive cities in Massachusetts, such as Weston and Nantucket. In both of these areas, the average selling price for a home is well over the $1 million dollar mark.
To make matters worse for house hunters, housing prices here in Massachusetts are steadily on the rise. You can thank the upward growth in population numbers for the rising housing prices. Within the last 10 years, our state's population has increased by 4.77%. More demand and less supply always equals higher prices.
However, some experts fear that the new tax law would lead to as much as a 10% drop in home values. As a result, homeowners could lose a lot of equity.
The good news is that current homeowners will not be affected by the lower mortgage interest deduction threshold. Existing mortgages are still eligible for an up to $1 million dollar mortgage deduction.
On the flip side, would-be sellers may be unmotivated to sell in response to the lower deduction cap. Why sell their current home if they won’t be able to deduct as much on a newer home? This will indeed lead to higher prices on the homes that are for sale, because of the sheer lack of homes on the market.
Another potential drawback of the reduced mortgage interest deduction is the fact that some buyers might actually downsize in an effort to get the maximum deduction. It may also mean that home buyers who are shopping for a second home will be less likely to do for so, especially if the home will be over the deduction limit. For real estate agents, this practice can impact commission.
It’s not all bad news for those who want to sell, though.
Homeowners who do plan to sell their home for profit will still be able to enjoy a tax break. When selling their primary home, a taxpayer will be able to exclude up to $500,000 from capital gains. The fine print here is that the homeowner must have owned this home for a minimum of five years and also lived in this home for at least two of those five years.
Under the previous tax law, you could claim a deduction for interest on home equity loans up to $100,000. With the new tax law, that deduction is totally eliminated. This isn't a huge concern for real estate agents, but it will limit homeowners' ability to access the equity in the homes with these loan products.
The SALT deduction, which also includes sales and property taxes, has been limited, but not completely eliminated. Although the previous federal deduction for state and local income and sales taxes was unlimited, the new law limits taxpayers to a deductible max of $10,000 in combined state, local income, and property taxes. This means that homeowners with high local and state tax bills can expect to pay more taxes in 2018 than they would have previously.
Navigating the new tax law can be tricky, especially if reading about deductions and exemptions makes your eyes cross. Hopefully the above introduction will give you a solid overview so that you’re prepared to discuss these important changes with your clients. And of course, please note that this post does not serve as legal advice. For further clarification on the new tax bill, always consult your tax attorney or CPA!