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Tax Reform – Impact on housing and homeownership
By NAR Staff
Homeownership was, is, and likely always will be the American Dream. Today, 74 million U.S. households own their own home. This near 70 percent homeownership rate helps drive the nation’s economy through direct and indirect contributions to the gross domestic product (GDP). In addition, homeownership helps households build up their net worth – household wealth – which allows for healthy consumer spending in all sectors of our economy.
Earlier this month, the President’s Advisory Tax Reform panel released its recommendations. Some of their proposals could have devastating impacts on the nation’s housing economy and negatively impact the nation’s economy as a whole. The National Association of REALTORS® is already working to fight any threats to homeownership that could result from the recommendations included in the reform package. NAR’s Research Division has made some preliminary calculations showing the financial impact on homeowners resulting from some of the Panel’s recommendations.*
Tax Reform Panel proposals
There are four major components recommended by the Advisory Panel on Tax Reform that could significantly impact residential housing:
- Conversion of the mortgage interest deduction from the current $1 million mortgage loan to a 15 percent tax credit only up to the FHA loan limit (which ranges from $172,000 to $312,000 depending on locality).
- Elimination of the mortgage interest deduction for home equity loans and mortgages on a second home.
- Elimination of the local property tax deduction.
- Raising the capital gains tax-free allowance to $300,000/$6000 from $250,000/$500,000 (single/married).
The impact on eliminating or changing any part of the mortgage interest deduction has been garnering a great deal of media coverage. And going forward, NAR will be doing more intensive research on this issue. But the elimination of the local property tax deduction could also wreak havoc on home prices, and therefore on the net household worth of homeowners, as well as housing activity and REALTOR® business.
Non-deductibility of property tax: impact on homeowning taxpayers
It’s this simple: eliminating the deductibility of property taxes will increase homeowners’ tax bills. In 2003, 40.1 million U.S. homeowners claimed $112 billion in property tax deductions for federal income tax purposes. In other words, U.S. homeowners reduced their federal tax liability by 26.5 percent of the $112 billion in deductions – or by $29.7 billion in 2003. NAR estimates that in 2005, the itemized deductions for real property tax payments will rise to $131 billion, based on the recent growth in home prices and an increase in the number of taxpayers who itemize. (This is based on the increase in the number of homeowners in the last two years and a corresponding increase in the number of filers who itemize deductions). Based on the 2003 average federal tax benefit of 26.5 percent of the itemized property tax payments, in 2005, the reduction in the homeowners’ federal income tax liability is estimated to be $34.7 billion.
Impact on home prices
While increasing homeowners’ taxes, repealing the deduction for real property taxes would reduce home prices. The current property tax benefit applies not only in tax year 2005, but for future years as well (assuming no changes in the tax law). Let’s look at the total benefit of deducting property taxes, which includes the value calculated for future years. Over the coming years, the amount of property taxes is adjusted to reflect growth in home prices (hence, growth in property tax payment) and then discounted to express it in present value terms. Under a reasonable set of alternative price growth and discount rate scenarios, the net present value of tax benefits is estimated to be $780 billion, plus or minus $100 billion, or between $680 billion and $880 billion (see table). If the property deduction is no longer permitted, aggregate-housing valuation would decline by the amount of the net present value.
Even those homeowners who do not itemize their deductions would feel the impact of the nondeductibility of property taxes. The decline in home prices (value) would affect all homeowners regardless of the individual homeowner’s tax filing status. Therefore, the $780 billion reduction in aggregate valuation would reduce home prices by an average of $10,500 for all of the nation’s 74 million homeowners. That is equivalent to a 5.4 percent decline in home price.
Impact on market activity and REALTORS®
The reduction in home prices would not be an instant event. But over time, incentives for existing homeowners to continue owning would likely decline. Potential homeowners would no longer be able to include the property tax deduction in their home purchase cost calculations before buying a home. Thus, it could appear to inflate the upfront purchase cost of a home. This has the potential for “scaring away” homebuyers. Therefore, a steadily declining demand would reduce home sales. Fewer sales mean less business for REALTORS®.
State level impact
The impact on individual states will vary given the current variations in the federal tax benefits of property tax deductions. New York claimed $11.4 billion in deduction while Texas (a state with two million more residents than New York) claimed $7.8 billion in property tax deductions. Furthermore, due to varying income distribution among states, a tax dollar benefit for each dollar of property tax deduction differs among states. For example, based on 2003 IRS data, Montana homeowners reduced their tax liability by 23 percent of the deduction claimed, while Washington, D.C. residents reduced their tax liability by 29 percent of the deductible amount, compared with the average federal tax benefit of 26.5 percent.
The impact on state home prices would also vary. If the property tax is eliminated, New Jersey would likely see the largest decrease, with its average home price declining by $28,200 (under the baseline scenario described above). New York and Connecticut would also feel the price chill, with average prices in those states declining by $23,075 and $22,513, respectively.
NAR – Protecting tax benefits of homeownership
Real estate is a long-term investment, and 70 percent of U.S. households have invested in housing. Eliminating just the property tax deduction – as recommended by the Tax Reform Panel – would have a measurable impact on homeowners and real estate markets. It is likely that in combination with the Panel’s other proposals concerning the mortgage interest deduction (eliminating or converting to a tax credit), the value of the nation’s residential property could decline 10 to 15 percent. The panel’s recommendations could impact the value of every home, whether it is financed or not.
The National Association of REALTORS® recognizes the vital role that housing-related tax benefits play in the housing market. The Association is supporting new research to determine the economic effects of the Panel’s recommendations, especially their impact on the value of residential and commercial real estate and their impact on homeownership. NAR’s Research and Government Affairs divisions will be working with members and others to insure that the U.S. tax system:
- Treats homeownership as an investment and not as a consumption good;
- Encourages savings and tax-based incentives for home purchases; and
- Eliminates penalties for using savings for home purchases.
The Association will protect the property tax and mortgage interest deductions that have played a central role in advancing homeownership in America since the federal income tax code was adopted in 1913. Updates on the latest developments on this vital issue to America’s homeowners – and REALTORS® – will be posted on REALTOR.org.
For the latest developments and research on the Tax Reform Panel’s recommendations, be sure to visit REALTOR.org. To read the full report from the President’s Advisory Tax Reform Panel, visit http://www.taxreformpanel.gov.
Reprinted from Real Estate Insights November 2005 with permission of the NATIONAL ASSOCIATION OF REALTORS®. Copyright 2005. All rights reserved. |
