The Long and Short of Tax Reform Plan : Realtors, Mortgage Bankers Differ on Its Impact on Housing
Like every other aspect of President Reagan’s proposed tax reform plan, the effect on real estate--whether shelter or tax shelter--is subject to much speculation.
Here’s a rundown of the implications.
Although the plan guarantees that you can keep your home’s mortgage interest deduction, the tax plan would do away with write-offs for real estate property taxes.
That, plus the reduced value of interest deductions because of lower tax brackets, hikes the after-tax cost of homeownership for anyone who has been itemizing deductions. (About half of all homeowners don’t itemize.)
The National Assn. of Realtors is sure that this will keep many Americans out the housing market and force down the value of homes.
More Disposable Income
However, there’s another side. Although your home won’t generate as many tax savings as in the past, your tax bill may go down anyway, thanks to the rate cuts and other tax savers in the Reagan plan.
The Mortgage Bankers Assn. figures that most homeowners and home buyers will have more disposable income, and that some of it will go to housing. When it comes to how large a mortgage you can afford, lenders look at after-tax income, not at the after-tax cost of the mortgage payment and property taxes.
A home remains perhaps the most tax-favored investment because you get to keep the mortgage interest deduction and any profit on the sale gets special treatment. And if various provisions of the reform plan force residential rents to rise, any threat to home values will be further allayed.
Although depreciable real estate loses capital-gains treatment on profits, the break is preserved for your home. You will still be permitted to put off the tax bill on a sale by rolling the profit into a new home, and once you’re 55 years old you can qualify to take up to $125,000 profit tax free.
Inflation Adjustment
Property you own now or buy and put into service by end of the year retains the capital gains treatment, regardless of when in the future you sell it. It would also be spared the longer depreciation periods called for. Reagan’s plan would stretch the write-off period from 19 years to 28 years.
On the plus side, the plan would allow you to base deductions on the inflation-adjusted value of the property. Under the reform plan’s capital cost recovery system, depreciation deductions would be based on increasing percentages of the inflation-adjusted basis of the building.
For a building put into service on July 1, the first-year write-off would be 2% of the depreciable amount, for example. In year two, it would be 4% of the remaining basis, arrived at by subtracting the first-year deduction and adding an allowance for the year’s inflation.
And so on, until in year 28, you would claim 66% of the remaining inflation-adjusted basis. In year 29, you’d deduct whatever was left. The write-offs stretch over 29 years, rather than 28, because of the way the depreciation schedule is figured under the President’s plan.
Buying Considerations
Is now the time to rush out to buy rental real estate? There might be some good buys, but there are numerous factors to take into consideration.
Even the faster write-offs decline in value, for example, if your tax rate drops. And if your investment rests on the value of resale, remember that tax benefits you lock in today disappear when you sell it: Whoever buys it, once the new rules are in effect, would get only the restricted tax benefits.
Note this: The restrictions on interest deductions, discussed below, would not affect your rental property. Mortgage interest would continue to be fully deductible as a business expense. Ditto for real estate taxes.
To hear some people tell it, the market for second homes--not a rental property but a place at the beach or the mountains that you use for vacations, for example, would be destroyed by the President’s proposal. Not so.
The perceived threat is the proposed limit on interest deductions. Basically, starting next year, you would add up all your interest expenses on car loans, credit cards, margin accounts, vacation homes and etc. Mortgage interest on your principal residence doesn’t count.
Only the first $5,000 would be deductible; any excess would be carried over to a future year when it might again be nailed by the $5,000 limit.
On the other hand, $5,000 in interest can support a lot of debt. Also, phase-in rules would put the cap at $10,000 in 1986 and 1987. And the $5,000-$10,000 caps represent the minimum amount of interest you can deduct.
That cap is raised by the amount of investment income you earn during the year--from interest, dividends, rents and royalties, for example.
Also, in 1986 only 10% of the debt on the second home and consumer loans would fall prey to the cap; in 1987 it would be 20%, and so on until the rule is fully phased in, in 1995.
As proposed, the President’s plan would permit using a second mortgage on your principal residence or refinancing that mortgage to generate the cash to pay for a second home. As long as the interest you pay on a loan is secured by your principal home, it wouldn’t come under the cap.
Probably more significant than the impact of the interest limits, is how an investment in a second home would be affected by the loss of the deduction for real estate taxes on the place and the reduced value of mortgage interest deductions if you fall into a lower bracket.
The proposed tax changes appear to be adding to sellers’ problems in areas where the market is soft anyway--in southeast Florida, for example--but are being ignored in strong markets, such as Cape Cod.
If you’re considering buying a second home, you may want to toss the potentially reduced tax benefits into the negotiations in an attempt to pull down the price. It might work, depending on market conditions.
On the other hand, if you plan to sell this summer, don’t panic and be bamboozled into accepting a low-ball offer.
