Reduction of the SALT Deduction
Without question, the most significant change facing California homeowners is the dramatic limitation on the deductibility of state and local taxes (“SALT”), including both state income taxes and county real property taxes. Although, under the newly enacted rules, taxpayers are permitted to deduct up to $10,000 in state and local taxes, most people that can afford to purchase real estate in Silicon Valley already pay over $10,000 in state income taxes so this change effectively eliminates the deductibility of all property taxes. This change will reduce the incentive for the purchase of real estate.
Longer term, this change may make it more difficult to attract top talent to the state. As a result, we are likely to see businesses locate high paid operations out of state to the extent practicable. Naturally, these concerns will be counterbalanced, to some degree, by the overall desirability of the state and the robust business environment.
Although we expect this provision to have an immediate and significant impact on the buyers’ desire to purchase homes, this impact should diminish over time as some taxpayers realize that state and local taxes were a “preference item” under the AMT rules, and, as such, were already added back. In other words, not all taxpayers were getting a benefit from the SALT deduction so the loss of it will not hurt them as much as they may fear at first.
Reduction in Mortgage Interest Deduction
Under the new law, mortgage interest on loans used to purchase property will only be deductible to the extent of the first $750,000 of principal amount. This is down from $1.1 million, which was the combined limit of the $1 million mortgage mount and the $100,000 equity line, which could be aggregated to form a combined limit of $1.1 million. Although existing loans, and the refinance of existing loans, will retain the $1 million principal amount limitation, the additional $100,000 has been eliminated.
We do not expect this change to have significant impact on the psyche of potential buyers because interest rates are so low and buyers of expensive real estate have proven undaunted by the non-deductibility of a portion of their mortgage interest.
Overall Reduction in Incentives to Buy Homes
The near doubling of the standard deduction, and the reduction of the deductibility of state taxes and mortgage interest, will have the unintended consequence of reducing the incentive for people to buy rather than rent. We expect this impact to be most pronounced on lower priced homes, but the entire market should feel some sort of effect. While there are both benefits and detriments associated with entry level homes becoming more affordable, current homeowners may want to be prepared for a turbulent ride.
No Elimination of the Individual AMT (but Exemption Increased to $1,000,000 for Couples)
Although the House Bill called for the repeal of the Alternative Minimum Tax (“AMT”) for individuals, the final legislation retained the Individual AMT, but eliminated the corporate AMT. However, the legislation raises the point at which the AMT exemption is phased out, from $164,100 for joint filers to $1,000,000 for joint fillers. This increased limit, coupled with the reduction of available deductions, should result in a much lower percentage of the population paying AMT.
Changes for Individual Income Tax to Sunset After 2025
Much has been made about the fact that the changes to personal income taxes will sunset after 2025, whereas the corporate changes are permanent. However, I believe this is more of an administrative requirement rather than the long-term intent of the legislation.
Under the “Byrd Rule,” any plan for tax reform cannot add to the deficit beyond a 10-year budget window. If it does, a super-majority of 60 votes would be required to pass the Senate, which would require bi-partisan support. By including the sunset provision, only a simple majority was required. Presumably, Congress could extend these changes by simple majority as the 2025 date approaches.
Thus, we believe that the sunset provision was one of legislative convenience, rather than a telegraphing of a long-term intent to eliminate the tax changes for individuals.
No Change to Capital Gains Tax Rates (Including the 3.8% Surtax)
Many had hoped that there would be a decrease to the capital gains tax rates, which start at 15% for federal purposes and increase to 23.8%, inclusive of the 3.8% tax on Net Investment Income to fund the Affordable Healthcare Act (i.e., “Obamacare”). Unfortunately, the new legislation leaves these rates in place, including the 3.8% surtax.
Personal Exemption ($4,150) Suspended
While the Standard Deduction was increased from $12,700 to $24,000, the personal exemption of $4,150 per dependent was suspended. Thus, the net effect of these two provision will vary from family to family. It should be noted that the old personal exemption was phased out for couples making over $320,000 whereas the phase-out of deductions has been eliminated under the new legislation.