The Effects of the Tax Bill on Housing in California
The effects of the tax bill are regional. They vary greatly from state to state because property tax rates and state income tax rates are very different from state to state. There are two parts of the bill which could affect folks’ decisions about home buying. These are 1) the limit on the deductibility of mortgage interest lowered to $750,000 from $1,000,000. (33% of the purchase loans RPM does are above $750,000. 14% of RPM loans are above $750,000 and below $1,000,000.) 2) The limit of the deductibility of property tax plus state and local tax.
The purpose here is not to assess the overall effect of the Tax Bill on the economy or nationwide housing but solely to assess the effect on home prices in California. This is limited to people buying homes because I am trying here to calculate only the effect of the Tax Bill on people’s decisions about purchasing.
I do not believe that the changes to the tax code will significantly affect home prices in California.
Why? Look at the numbers. With a 4% interest rate on a loan of $1,000,000, the amount of mortgage interest in the first 12 months is $35,718.54. Tax rates are tiered. Assuming that the 2017 marginal tax rate for a couple who could afford a $1,000,000 mortgage is 28% (the marginal tax rate for income $153,100 to $233,350 for a married couple) the previous savings in tax from that deduction would be $10,001. Under the new tax bill, the marginal tax rate for a couple with income between $165,000-$315,000 is 24%. If one could only deduct interest on $750,000 the amount of deductible interest would be $29,759.60 and the saving in tax at the marginal tax rate of 24% would be $7,142. The max hit would be $10,001 - $7,142 or $2,859 in the first year or $238/month.
As time goes on the interest/year decreases and so does the hit.
Limitation on Property Tax and State Income Tax deduction
California as compared to other states has relatively low property taxes and the highest by far marginal income tax rate of any state in the nation. In California the marginal state income tax rate on income above $105,224, but less than $537,500, is 10.3%. A married couple purchasing a house for $1,000,000 with an annual income of $200,000 will have property tax of about $12,500/year and state income tax of $15,640 for a total of $28,140 in property tax plus state income tax. The new bill limits the total deduction of these to $10,000, thus making them pay the marginal Federal Income Tax rate of 24% of the extra $18,140 for an increase of $4,354 in Federal Income Tax.
Adding together the $2,859 due to the lower cap on mortgage interest deduction and the $4,354 due to the limitation on property tax plus state income tax, we have an annual hit of $7,213 for a married couple earning $200,000/year purchasing a $1,000,000 home with 20% down.
The effect is different for each taxpayer and I have chosen an example which I believe illustrates a couple with an above average hit to Federal income tax.
Looking at this at a local level, let’s just look at the San Francisco Bay Area. Here homes are expensive and people have relatively high incomes. They will not be happy about forking over an extra $7,213 per year to IRS, but this will stop almost no one from purchasing a home. Demand for housing is so great compared to supply that I would estimate the effect not as lowering home prices but perhaps slightly slowing down the rate of increase in home prices. This slowing in the gain in home prices is, in my view, a completely desirable effect.
A larger issue is why homes are so expensive in the San Francisco Bay Area. There is no mystery here. Absent a recession, we will not see lower home prices until supply is increased to satisfy demand. With the Bay Area economy adding jobs, people need places to live. Whether they buy or rent, housing is needed. Land use regulations in the Bay Area and especially zoning prevent the building of housing that property owners and developers want to build and families want to buy.