The Republican tax plan released Thursday seeks to dramatically rewrite rules that have shaped the housing market for decades, potentially dealing a blow to California, where a shortage of housing has led to some of the highest home prices in the nation.
Under current law, homeowners can deduct interest paid on as much as $1 million in mortgage debt. Republicans would allow that to remain for existing loans, but for new purchases, owners would be able to deduct only the interest paid on the first $500,000.
In much of the country, the change would have little effect, but in some corners of the state, including Orange and Los Angeles counties, prices have already surpassed levels reached during last decade's housing bubble.
"It's a blow for California," said Nela Richardson, chief economist at online real estate brokerage Redfin.
The median price in September for single-family homes statewide was $555,410, according to the California Assn. of Realtors. That means half the homes that month sold for more and half for less.
The median for all homes — houses and condominiums — was well above that in corners of Southern California, hitting $575,000 in Los Angeles County and $710,000 in Orange County in September, according to a separate report from CoreLogic.
"In major California cities you are not going to even find a starter home for $500,000," Richardson said.
If passed into law, the tax changes wouldn't affect mortgages already under a binding contract.
The halving of the mortgage interest deduction will not only hit some home buyers directly, but it also could create an incentive for existing homeowners to stay in their house and not move up in the market. That would potentially restrict both the supply and demand, leading to a slowdown in sales.
From 2013 to 2015, when prices were lower, 20% of mortgages taken out in California exceeded $500,000, according to a report from the National Low Income Housing Coalition.
Though people in states with high property values could be hurt by these changes, Republicans say other aspects of their proposal will result in overall tax savings, including by doubling the standard deduction for couples to $24,000 and revising individual income brackets to help lower effective tax rates.
However, the larger proposal would also bar individuals from deducting state and local income or sales taxes, while limiting the property tax deduction to $10,000.
Given California's high income tax, the loss of the state and local deduction would hurt, while the property tax cap would not be as big of a deal for many longtime owners, because Proposition 13 limits how high that tax can rise.
In 2014, Californians claimed $70 billion in federal deductions for state and local income taxes but only $27 billion in real estate, personal property and other taxes, according to the California Franchise Tax Board.
The real estate and building industry came out strongly Thursday against the proposals.
Doubling the standard deduction would mean fewer homeowners would itemize their deductions in the first place, a requirement to use the mortgage interest deduction.
That, along with the $500,000 limit on loans eligible for the mortgage interest deduction, would take away a major selling point from real estate agents, who often mention the deduction as a reason to become a homeowner.
The National Assn. of Realtors argues the proposal would even lead to lower housing prices overall by limiting the financial incentive to buy instead of rent. In talking points, the group says that "proposals limiting tax incentives for homeownership would cause home values everywhere to plunge."
If true, that would be welcomed by many first-time buyers, especially in California, but even that scenario wasn't welcomed by some in the industry.
"Even if home prices decrease, the cost of owning a home will go up, which would be a tax increase on the middle class," Lotus Lou, a spokeswoman for the California Assn. of Realtors, said in an email.
Still, some economists said it is highly unlikely the changes would cause prices to plunge.
The market is too hot, and although sales could slow, the difference in tax savings is small enough that the market isn't likely to face the drastic changes forecast by the real estate industry.
According to an analysis by the nonpartisan Tax Policy Center, about 489,000 tax filers in the state would have paid an average of $3,290 more in federal taxes if the $500,000 mortgage interest cap covered current loans.
Richard Green, director of the USC Lusk Center for Real Estate, said limiting the deduction would probably make home prices in the $515,000 to $1.25 million range a "couple of percentage points" lower than they otherwise would be, but the effect on the overall market would be muted.
"Because prices are going up anyway, maybe this would flatten prices out for a while, which wouldn't be the end of the world," he said.
Tregg Rustad, a Rodeo Realty real estate agent who works on the Westside of Los Angeles, predicted many of his clients would be paying more to own a home if the proposal passed.
But he agreed with economists who said the changes wouldn't dramatically harm sales because the deduction isn't the driving factor when deciding to buy a home.
"It's something to keep an eye on, but I am not worried," he said.