For months we’ve been inundated with headlines about rocketing home values and the housing supply crunch. Plenty of pontificators have tried to spell out the reasons for the supply crunch. Many blame the slowdown in new home construction since the housing market crash of 2008. They point the finger towards nearly 15 years of below-average new home starts. We’ve generally accepted that the growth of new supply hasn’t kept up with the pressures of demand from an aging-in population.
Population projections show us that the demand for homes will remain steady for the foreseeable future. As millennials age into homeownership, their familial needs will continue to drive the demand for housing. For many, the new work-from-home standard highlights the need for square footage—and a lot of it. Home-seeking millennials will continue to need family homes with a reasonable amount of living space.
The SALT deduction cap placed an instant tax burden on many upper middle-income families in mega markets around the country, a.k.a. big cities. It restricted the tax write-off for state and local income taxes and property taxes to a combined total of $10,000. While this write-off only affects those who itemize their tax deductions, many homeowners and would-be-buyers have counted on this tax benefit as motivation to buy. For many new buyers in major cities, property taxes, alone, exceed this $10,000 write-off.
How Does SALT Affect Families in High-Value Metropolises?
Data collected from the IRS in 2019 shows that roughly 11% of taxpayers itemize deductions on their taxes. This is likely a byproduct of the standard deduction increase to $12,950 for individual filers, $25,900 for married couples. But in mega-tropolises where the housing market seems to be going nuts, where values often exceed $1M, buyers are typically—or would be—part of this 11.4%.
How It Looks on Paper
A young family of four purchasing a 2,200 sq-ft house in Southern California might easily pay $1.2M in today’s market. Property taxes, assuming the home is not subject to additional special improvement tax bonds, might run around $15,600. Yet the new homeowner can only deduct $10,000 of that amount on income taxes. To add insult to injury to this young family, the taxes paid to state and local governments (high in California) cannot be deducted. They will max their deduction on property taxes, alone.
For States like Texas and Connecticut with a reputation for high property taxes and high home values, the $10,000 limit is quickly maxed. An $800,000 family home in Ft. Worth might have a property tax bill of over $17,000. Fortunately, the state of Texas does not tax income. But sales tax in a growing metropolis like Ft. Worth runs 8.25%, nearly 2% higher than the national average. Under current SALT deduction limits, none of the taxpayers’ sales taxes are deductible for that year if they take the $10,000 property tax deduction. And one can imagine the sales taxes an active family might shell out in a year, especially a family furnishing an $800,000 home.
Generational Trends as They Relate to the Housing Market
The SALT deduction limitations have a big impact on housing supply and the natural movement of buyers and sellers as they relate to generational trends. We’re used to the natural order of things: young buyers buy small starter homes, then look for bigger homes when they start to have families. And then they look for even bigger homes when their families grow, or when a pandemic pushes both working parents into a home office.
Empty nesters become sellers, typically selling their larger family homes to these move-up buyers. Then these empty nesters look to downsize into smaller, often single-story, residences. These natural life cycle changes help keep a healthy flow of supply and demand in the housing marketplace.
But when a burdensome tax law increases a young family’s overall tax liability, potential buyers and sellers start to rethink their plans to move. You might think that the inability to deduct $12,000 or $10,000 worth of taxes paid isn’t enough to stagnate supply. You’re right. It may not be. But it isn’t working alone here. The new 2017 federal tax guidelines also limit the amount of mortgage interest a family can deduct from their taxes. It limited the deduction to the interest paid on mortgage loans up to $750,000. That means that any interest on a mortgage amount over and above $750,000 is not deductible.
So you can see how these deductions, or non deductions, start to add up. It’s enough to give buyers and sellers pause. In markets where mortgages on space-friendly homes are very regularly exceeding $750,000, these market movers aren’t that motivated to move. And while these existing homeowners are deciding to sit tight and wait things out, new first- time buyers are coming up, getting older, getting married, having kids. They still need homes.
This interruption in the natural order of a balanced supply and demand puts market pressure on the homes that are available, thereby increasing values—rapidly.
Example of the SALT Cap’s Tax Burden
Using our Southern California example and a $1.2M purchase price, this young family might easily be leaving nearly $20,000 of deductions on the table. We’ll assume this family has an adjusted gross income of $150,000. With their current California tax rate of 9.3% and a federal tax rate of 24%, this family’s tax burden increased by nearly $5,000. Here’s the math:
State Income Tax: $13,950
Un-Deducted Property Taxes: $5,600 ($15,600-$10,000)
Total Unallowable Deductions $19,550
$19,550 X 24% Federal Tax Rate = $4,692 Additional Taxes
Will the Removal of the SALT Deduction Cap Bring Back Natural Order to the Market?
It might. That $4,700 in additional tax payments puts a strain on a young family’s budget. That’s an amount that could cover a car payment, college savings for kids, or even IRA contributions. And don’t forget that additional taxes must be considered in addition to the expenditures associated with moving to a new house. Think bigger mortgage payment, higher property taxes, utilities, and so on.
Fortunately, the SALT cap is set to go away for tax year 2026. That doesn’t mean Congress can’t bring it back. Lawmakers in both the House and the Senate have introduced legislation that would restore the SALT deduction cap after its impending expiration in 2025.
The opposition against the SALT deduction limit is quite contentious overall as representatives argue that it hurts residents in high-tax states. So while the fate of the SALT cap is unclear at best, homeowners in high value markets might stay put during the SALT era, squeezing out supply and potentially bolstering home values.
Comments
Post a Comment