On Dec. 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA). The TCJA reduced personal income tax rates in most brackets and substantially reduced the corporate tax rate (from 35% to 21%). Politics aside, these reductions were cheered by many across the country. However, as has been proven over and over again, nothing is truly free, and tax cuts have to be otherwise paid for absent a reduction of spending. Given the latest omnibus bill passed by Congress, clearly no spending cuts are on the horizon.
To partially offset the income tax bracket reductions and loss of resulting income to the federal government, the Trump Tax Bill instituted a cap on the amount of state and local taxes (SALT) that can be deducted. For the vast amount of citizens throughout the country that itemize deductions, the amount of SALT that can deducted was limited to $10,000. To further offset, the Trump Tax Bill weakened the mortgage interest deduction by reducing the limit of mortgage principal (on which interest is paid) from $1 million to $750,000. These changes went into effect starting with the 2018 tax year.
A reasonable argument can be made that changes to itemized deductions resulted in a substantial penalty to owners and potentials owners of real estate in high tax “Blue States” such as New York and California. However, one must ask the questions whether this is truly the federal government’s problem. Should the U.S. federal government give tax deductions to residents and property owners in high-tax states ?
A client of mine recently shared his family’s story of home ownership with me. When he and his wife purchased a single family home almost 16 years ago in suburban New York, the real estate taxes on the property were approximately $10,000. Today, the real estate taxes are almost double at approximately $20,000 and yet the property value is basically the same.
However, there is a stark difference between now and then from an income tax standpoint. On their 2004 federal income tax return, they were able to deduct all of their New York state income taxes as well as New York state and local real estate taxes. Today, they can only deduct $10,000 of that total combined tax burden. From an accounting standpoint, this couple is now effectively unable to deduct their $20,000 real estate tax bill as state income taxes ate up the entire SALT deduction. In addition, my clients can now only deduct mortgage interest on $750,000 of their principal mortgage balance outstanding. As much as these changes have encouraged this couple to sell, they openly wondered whether today’s families purchasing homes in highly populated Blue States like New York and California have the same incentive to buy a home as they did back in 2004.
Simply put, the answer is no. With that being the case, how does this fact not have an impact on the real estate markets in these areas? More often than not, the formula of higher taxes plus fewer deductions results in lower or stagnant property values―no matter how the math is computed. This has resulted in fewer transactions in most Blue State markets and, in most cases, a true buyer’s market.
Notwithstanding, the bigger question is whether it is the responsibility of the federal government to subsidize high tax Blue States by allowing deductions for said amounts on federal income tax returns. This is and should be a true and healthy debate. Private property rights and the American dream of homeownership have been at the core of this nation’s identity since it was founded. It is something that should be encouraged. More interested buyers means more homes built which means more jobs―jobs to those that harvest the wood, manufacture the roofing shingles etc., build and sell/market the homes. Real estate is and has always been a powerful driver of the U.S. economy.
Should someone in a low tax state in the Midwest who pays $3,000 a year in real estate taxes feel badly for someone paying $20,000 a year in real estate taxes in New York a la my clients ? Maybe not. But should that client have to effectively pay tax on the tax by losing the ability to deduct state taxes on their federal returns? It truly is an interesting debate; however, absent an unforeseen decrease in spending, tax cuts have to be paid for somehow.
On Dec. 17, 2019, a Democrat controlled House of Representatives passed a bill purporting to eliminate the $10,000 SALT cap and restore the top tax bracket to the pre-Trump rate of 39.6%. It is not expected to gain Republican support in the Senate and likely will not pass. This author’s hope is that the bill is amended to provide for a more reasonable SALT cap ($50,000 perhaps) bearing in mind that cost of living/property taxes vary from state to state. Lower taxes and greater home ownership incentivizing deductions are key to the continued growth and recovery of the national real estate market.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Michael J. Romer, Esq. is a partner at Romer Debbas LLP New York.