Final Tax Law Less Awful for Manhattan Beach Real Estate

By Dave Fratello | December 21st, 2017

The two tax bills Congress passed are now one new tax law.

We provided an analysis of the House & Senate bills 2 weeks ago (see "How New Tax Law Might Hit Manhattan Beach"), noting several areas of disagreement or discrepancies between each measure. With those differences resolved in conference, some expected outcomes could change.

Today, taking a first look at the final tax law from the perspective of MB real estate, on balance, it's improved.

Let's cover the same bases as we did in our original post.

Over $10K in State Income Tax/Property Tax No Longer Deductible

There's no real change to the biggest real estate negative in the tax law. The deductibility of property tax will be capped at $10,000 per year, and that figure still will not be indexed, meaning it becomes less valuable over time with inflation.

Many local homeowners and, especially, new home buyers will have property tax bills well in excess of $10,000. This cap hits everyone.

On a home assessed at $2.000M (about the median price of recent sales in Manhattan Beach), this would mean a loss of deductibility on almost $12,000 per year. On a $3.000M house, it's almost $23,000. (Here's our page on Manhattan Beach property taxes.)

What's that? You don't have $10,000 or more in property taxes to pay?

Here's where the law was improved: You can now deduct state income tax and property taxes up to a combined total of $10,000.

So this doesn't change the real estate portion of the equation, but it should be a meaningful improvement to some local residents' overall federal tax bills. We do all live in California, after all.

The $10,000 limit ends in 2026.

(Note: The alternative minimum tax [AMT] in existing law may already have limited the benefit of property tax writeoffs for some taxpayers locally. The AMT has now been significantly changed by the new tax law and may hit many fewer filers. Ask your tax pro.)

Home Sale Capital Gains Exclusion Unchanged (!)

There's no change to one of the areas of concern: The capital gains exemption for home sales.

Currently, a portion of capital gains from sale of a personal residence can be exempt from tax. That's $250,000 for an individual or $500,000 for a couple. To get the exemption, you must have lived in the home for 2 of the prior 5 years.

And now, after the conference, this remains the law.

Both the House and Senate bills would have required living 5 of the prior 8 years in the home, and there were other proposed limits.

The conferees simply cut out this unpopular provision. It was a chief target of the National Association of Realtors' lobbying effort.

Mortgage Interest Deduction Limited to $750K (Primary Residence)

A dispute over cuts to the mortgage interest deduction (MID) was resolved with a "split the difference" resolution.

Current law allows a tax deduction for interest paid on up to $1.000M of mortgage financing. (For taxpayers who itemize.) The House cut the deduction to interest on only $500K, but the Senate brought it back to $1.000M.

The final product: interest on $750K can be deducted for new purchases. Existing loans are unaffected.

The limit will return to $1.000M in 2026.

Here in Manhattan Beach and around the South Bay, a cap of $750K will actually provide some real benefit, more than the House's proposed $500K for sure, and won't as drastically alter a home buyer's calculations from the prior $1M limit.

As noted above, the "old" $1M limit is slated to come back in 2026.

For some perspective, in a recent span (2013-15), only about 2% of mortgages nationwide were for $750,000 or more, but almost 46% of those larger loans were made for California home purchases.

Mortgage Interest Deduction Allowed for Second Homes

Under the House bill, there would have been no option to deduct mortgage interest from second homes.

Instead, the $750K cap for the MID will include both primary residences and second homes. In other words, the total $750K cap can include interest from a second home. This is essentially current law with a lower cap.

Refi Loophole Added for MID

Under the bills as originally passed, refinancing of a loan would have been treated like a new purchase loan for purposes of the MID. That would create a reason not to refi.

A refinement added in conference can be called a beneficial loophole.

If you have a large mortgage from before passage of this tax law and you refinance it, you can keep the $1.000M interest deduction instead of being forced to operate under the new $750K limit. The refinanced loan will be treated as if it originated on the date of the initial loan.

Home Equity Loan Deduction Limited to Substantial Improvements

No interest on home equity loans will be deductible, unless the loan is for "substantial" improvements to the home.

Previously, interest on up to $100,000 was deductible regardless of the purpose.

This change applies now to all such loans, and not only to new ones. So if you have been deducting interest, you can't in the future, unless you meet the "substantial improvements" requirement. (Ask your tax pro.)

The old $100K limit will return in 2026.

Limited Casualty/Loss Deductions

There will be no more deduction for "personal casualty" losses, such as the uninsured costs for damages due to wildfires, earthquakes or other natural disasters, unless the event is a "federally declared disaster." This declaration is not always applied to wildfires, for instance, but typically is applied to major earthquakes.

The Big Picture

No doubt, the cost of owning a home here will go up, as will the cost of living in California. This was not an accident on the part of the bills' authors.

Home buyers next year will need to re-evaluate their costs of ownership in light of the tax law changes, and might be willing to pay less. (Then again, buyers always want to pay less.) The stage is definitely set for some tough negotiations in 2018.

The main impact comes from property tax deductibility. A series of additional negatives for real estate seem to have been eliminated or softened.

The final tax law is less awful, but not good news for local real estate.

Nationally, there were projections that the tax bills would reduce home prices by at least 5%, 8%-12% or more in "higher cost areas." With the last-minute changes, there will need to be new evaluations of those estimates.

And declining prices aren't always bad. Real estate runs in cycles. Buyers would love to catch a break after year upon year of home price increases in Manhattan Beach. They might be more motivated.

Mainly, we need to just see it all play out.

BONUS FOR TESLA LOVERS: A $7,500 tax credit for electric cars was retained. See, it wasn't all bad.

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