The Tax Cuts and Jobs Act passed in December 2017 made a number of changes to the tax code. How these changes are impacting the housing market, and particularly home values, is starting to come into focus. This article digests a study of this issue from the Cleveland Federal Reserve Bank and its importance for California’s housing market.
2018 tax changes
Nearly a year has passed since the passage of the federal tax changes in December 2017. These changes were broad and numerous, impacting taxpayers at all income levels — including homeowners — but especially California homeowners.
The 2018 tax changes shifted how homeowners take various deductions, including nearly doubling the standard deduction, resulting in:
- a tax cut for households that typically take the standard deduction, since the deduction is now much higher;
- more people taking the standard deduction who used to itemize, resulting in higher taxes for about half the people who used to itemize under the old rules; and
- for homeowners, fewer taxpayers are able to take the mortgage interest deduction (MID), since it requires itemizing to take the MID.
For those who continue to itemize their deductions, the new plan includes changes to:
- state and local (SALT) taxes, which are now limited to $10,000 per tax return;
- the MID ceiling, which has been lowered from mortgages of up to $1 million to mortgages of up to $750,000;
- interest on home equity lines of credit (HELOCs), which can now only qualify for the MID if they funded home improvements; and
- the deduction for moving expenses, which has been eliminated for all taxpayers but military families.
These changes have had a particular impact here in California, where both SALT taxes and mortgage amounts are higher than average. For example, the average Californian pays $18,438 in SALT taxes as of 2015, $8,438 more than the new ceiling.
Now that we’re nearly a year into the tax changes, what sort of impact have these changes had on the housing market? And what impact can we expect to see in California’s housing market in the years to come?
The potential impact on California home values
A study from the Cleveland Federal Reserve Bank has found that areas with high incomes and high housing costs received the most blowback from the tax changes. In other words, taxpayers who own expensive homes are paying higher taxes under the new rules.
In fact, the study shows the higher tax burden on homeowners will cause an average 5.7% drop in home values. The impact is highest for those upper-middle class households with incomes around $100,000-$200,000, averaging -11.3%. This average drop is much higher across California.
Of course, home prices have not actually dropped in California since the 2018 tax changes went into effect. Rather, the study is suggesting that the tax changes will eventually result in home prices 5.7% lower than they otherwise would have been under the old tax rules.
In California, the average price difference due to the new tax laws is expected to be:
- -8.4% in Bakersfield
- -7.0% in Fresno
- -8.4% in Los Angeles
- -8.6% in Oakland
- -8.6% in Riverside
- -8.5% in San Diego
- -5.9% in San Francisco
- -7.7% in San Jose
- -7.1% in Stockton; and
- -8.7% in Vallejo.
The study also suggests if large price declines occur due to a recession or other economic event, the decline may be magnified.
Taxes matter — sort of
Taxes have a strong influence over purchase decisions, but never have the final say.
A recent Redfin survey asked homebuyers how 2018 tax reform has impacted their home purchase behaviors. The tax changes caused:
- 8% of homebuyers to move their search to another state;
- 9% of homebuyers to move their home search to a different city with lower taxes;
- 10% to purchase a less expensive home; and
- 10% to purchase a more expensive home.
In the end, the vast majority of potential homebuyer still purchase, regardless of how taxes are charged. This has been a steady chant from MID detractors, who say the subsidy is worthless in promoting homeownership.
But taxes do have an impact on the amount of money homebuyers are able to spend on their purchase, which impacts home values. As the survey results tell us, the 2018 tax changes resulted in more money to spend for some, while others have found their budgets diminished due to the tax changes.
The balance will shift in the future as the number of taxpayers paying less will dwindle each year. That’s because the way the Internal Revenue Service (IRS) measures inflation was also changed under the new rules. The result will be bracket creep, where more taxpayers end up earning into higher income brackets due to less generous inflation measures. Thus, more taxpayers will be paying higher tax rates than they otherwise would have.
Bracket creep, along with the other tax changes — not to mention rising interest rates — will gradually reduce homebuyer purchasing power along with home values in the coming years.
Despite these changes, homebuyers will continue to purchase, lured by the homeownership dream.