It’s time to brush up on tax basics. The U.S. Senate has passed its tax reform bill, meaning the tax code in 2018 will look very different from prior years. Reporting for 2017 taxes remains unchanged.

Now that the Senate has passed its version of the bill, it will need to reconcile it with the House of Representatives, which passed a similar — but ultimately different — bill. This reconciliation will occur in a conference committee between the two legislative bodies before the final bill is sent to the President’s desk.

Therefore, the details of the tax bill will change slightly in the coming days. Both versions of the bill include the following:

  • eliminating deductions for state and local income taxes;
  • increasing the length of time a homeowner needs to occupy their residence to take the principal residence profit exclusion from two of the last five years to five of the last eight years;
  • doubling the size of the standard deduction, making it less beneficial for most families to itemize deductions like the MID; and
  • restricting deductions for moving expenses on moves of at least 50 miles to military members only.

It’s likely these bi-cameral changes will make it to the final bill.

The House’s version of the bill includes:

  • reducing the deduction on property taxes to $10,000;
  • limiting the amount of mortgage that qualifies for the mortgage interest deduction (MID) from $1.1 million to $500,000; and
  • eliminating the exemption on private activity bonds, which are used to finance affordable housing projects in California, including 20,000 newly constructed homes in 2016.

The Senate’s version of the bill limits the amount of mortgage that qualifies for the MID from $1.1 million to $1 million.

Members of the House and Senate will debate their differences in the coming days, but will keep the amendments to the tax code (above) they have already agreed on.

How tax changes will impact California real estate

California has some of the highest tax rates in the nation, and the inability to deduct these payments will translate to residents paying much more in taxes than they are used to paying. On the other hand, this legislation rewards states like Texas and Florida, where income and property taxes are quite low.

Homebuyers surveyed by Redfin in November 2017 were asked if they will consider moving out of state if deductions for state, local and property taxes are eliminated. In California, 17% said they would seriously consider moving and 14% said they would consider moving. 6% said they will absolutely move.

We’ll have to wait and see how the committee ultimately decides to alter these tax deductions. But since both have agreed to eliminate state and local income tax deductions — and are still debating the fate of property tax deductions — we can expect to see a tangible impact on Californians no matter what.

Another thing we will need to wait and see about is the MID.

The House’s proposal reduces the mortgage amount eligible for the MID to $500,000. Including changes to the standard deduction, this would decrease the number of homeowners currently eligible for the MID from:

  • 99% in San Francisco to 59%;
  • 96% in Los Angeles to 30%;
  • 94% in San Diego to 20%;
  • 73% in Sacramento to 5%; and
  • 56% in Riverside to 3%, according to Zillow.

The Senate’s version of the bill does not include this decrease, so we will need to see what type of compromise is reached.

One thing included on both tax bills is the increased length of time needed to take the principal residence profit exclusion, which allows homeowners to skip capital gains tax on the sale of their home.

The current law allows a homeowner who has lived in their home for two of the last five years to sell their home without paying taxes on the profit. Under the new law, homeowners who sell their homes on or after January 1, 2018 will need to pay tax on their profit unless they’ve lived in the home for five of the last eight years.

This will deter potential sellers from listing their home until after they’ve lived in it for at least five years. A big problem for home inventory, this change is very likely to reduce the number of homes coming on the market in 2018 and the years following. Zillow estimates 11% of today’s home sellers have lived in their home between two and five years. These homeowners will hesitate to sell now that they will be required to pay taxes. In California, this is a difference of tens of thousands of dollars, enough to make sellers think twice before listing.

Check back before year’s end to see how this plays out in committee, as the tax consequences for real estate agents and their clients will be immense.