As we begin 2019, one thing we can universally look ahead to is paying taxes.
When you file 2018 taxes in the coming months, you can trust they will look fairly different from previous years due to the sweeping 2018 tax changes. In California, one change in particular is going to result in many residents paying significantly higher tax bills. That change is the new cap on the deduction for state and local income taxes (SALT).
One year on from the big tax shake up that occurred at the end of 2017, we examine how the cap on SALT payments is impacting California’s housing market in 2018 and in the coming years.
What changed with the SALT cap
Before the 2018 tax changes, taxpayers who itemized their deductions were able to deduct the full amount paid in SALT taxes each year, essentially avoiding paying taxes on their tax payments.
Now, SALT deductions are capped at $10,000 — the same for single and married taxpayers. For many Californians (and other taxpayers located in high-tax states, like New York and New Jersey), their SALT taxes well exceed the new cap. This translates to being taxed on additional income.
For example, the average Californian’s SALT bill is $18,438 as of 2015. California’s average SALT bill is the third-highest in the U.S. This is due to the state’s:
- high income tax rate; and
- high property taxes.
Adding the $10,000 cap increases the payment of an average California taxpayer who previously took the full SALT deduction by about $4,000, according to a statement against the changes by several California mayors.
Declining home values
When it comes to housing, taxpayers with the most expensive homes — and thus higher property tax payments — are paying more taxes under the new SALT limit.
Higher tax payments will have a domino effect on home sales in California, causing reduced home values, according to a study by the Cleveland Federal Reserve Bank.
The study finds the average home value change across the U.S. will be -5.7%. In other words, home values will be 5.7% lower than they otherwise would have been under the old rules which allowed taxpayers to deduct their full SALT payments.
However, due to the state’s higher home values, this reduction will be much more significant for California’s homeowners. Here, the average price difference due to the SALT cap will be:
- -8.7% in Vallejo;
- -8.6% in Oakland;
- -8.6% in Riverside;
- -8.5% in San Diego;
- -8.4% in Los Angeles;
- -8.4% in Bakersfield;
- -7.7% in San Jose;
- -7.1% in Stockton;
- -7.0% in Fresno; and
- -5.9% in San Francisco.
Moving to lower-cost states
Even as higher taxes will pull down home values, in the meantime, the state remains too expensive for some. That’s because California’s high quality of life comes with an equally high cost of living, a big part of why more Californians move to other states each year than enter, resulting in a negative net domestic migration rate.
Facing the prospect of paying even more taxes under the SALT changes, individuals in high-cost areas are now more likely to conduct their home search outside their metro, where home values are lower.
For example, Redfin analyzed the nation’s top ten metros with the highest SALT rates. It found that potential homebuyers in these expensive metros who are searching outside of their metros are focusing their searches in areas with tax rates three-times lower than the metros they are seeking to leave.
Further, Redfin surveyed homebuyers who recently completed their purchase in 2018, asking them how 2018’s tax changes impacted their home purchases. 8% responded that they moved their search out of state and 9% said they moved their search to a different city due to the tax changes.
Many Californians feel they have been treated unfairly in regard to federal taxes. Our state is classified as a donor state, meaning it sends more money to the federal government than it receives in benefits, according to California’s Legislative Analyst’s Office. This, on top of the double taxation on SALT payments over the $10,000 cap, is difficult to accept for Californians.
Voters negatively impacted by the tax changes made their displeasure known in November 2018’s election, when conservative Orange County saw the loss of four previously-Republican-held congressional seats to democrats.
Some have blamed the sweeping loss in Orange County and in other high-cost districts across the country on the Republicans’ decision to cap SALT deductions. 40% of taxpayers claim the SALT deduction in these districts, including neighborhoods like Newport Beach where more people use SALT deductions than almost anywhere else in the country.
Solving higher taxes
In 2018, state legislators attempted to work around the new SALT cap with SB 227, which would have allowed taxpayers exceeding the cap to re-classify their state income payments as charitable deductions. However, it was unclear whether the Internal Revenue Service (IRS) would have approved the law. Further, the proposed law was widely criticized as benefitting the state’s wealthiest individuals, and ultimately failed to pass.
As residents prepare for this year’s tax season, there is no workaround in sight. Already well used to paying some of the highest SALT taxes in the nation, Californians are going to have to learn to live with even higher taxes for the foreseeable future.
The difference between then and now is this: our state’s high SALT taxes go directly to supporting a higher standard of living across the state, as local taxes go toward supporting necessary local services like schools, emergency services, parks, roads, etc. Now, extra tax payments will be heading straight out of state.
This cap on SALT deductions tips the balance away from support for local governments and toward federal services. Californians don’t like it, but there’s not much we can do about it now, except pay up.