Big money is big money – a change in tax rate won’t cause rich families to uproot everything and move to an inferior place. What is more likely to cause millionaires to move? “The tax policy changes examined in this report are very modest compared to the life-impact of marital dissolution.”
Far more millionaires move into California than leave, despite the state’s highest-in-the-nation income-tax rate, a new study shows.
Researchers at Stanford University’s Center on Poverty and Inequality and the Franchise Tax Board sought to answer the question: Does California’s top state income-tax rate, now 13.3 percent on people earning $1 million a year or more, drive the wealthy to leave for low-tax states?
Short answer: No, except on the far margin.
The researchers reviewed 25 years of California tax returns from all high earners and found that more wealthy people relocate after a divorce.
Republicans regularly cite anecdotes of businesses owners and wealthy people decamping to low-tax states such as Nevada or Texas. But the study shows million-dollar earners moved to California even after voters raised income taxes in 2004 and 2012:
“We often think that the only way for a state to be ‘competitive’ is to be like Texas—a low-tax, low-infrastructure, low-services state. But the reality is that the most competitive places in the U.S., the leading drivers of the economy, and the centers for top talent are New York and California—and they have been for generations, despite higher taxes on top incomes.”
The Treasury Department and the IRS announced in Notice 2018-54 that they intend to propose regulations aimed at countering the efforts of California and other states in their attempts to help taxpayers get around the new $10,000 cap on state and local tax deductions.
Beginning with the January 2018 tax year, “The Tax Cuts and Jobs Act” (TCJA) limits the deduction of state and local taxes from an individual’s federal taxes to $10,000. For California and other high property value states that is likely to expose many taxpayers to an increase in their federal taxes.
In response, some state legislatures are considering proposals that in effect allow a tax payer to pay their state and local property taxes into funds that could be characterized as “charitable contributions” and thus be fully deductible on their federal tax returns. The “charitable” funds would then transfer the “contributions” to the state and local authorities to satisfy the taxpayers’ liabilities.
While this seemed like a way for saving many taxpayers from increased tax bills, the Treasury and IRS are saying not so fast. They remind all that federal law supersedes state law for federal tax law purposes, and that new regulations will be drafted to make this very clear to taxpayers.
Adam Blaylock was pretty sure he overpriced his Santa Clara, California, home by offering it in February for $1.48 million, since tax deduction changes would keep buyers away. But within a week, the 1,280-square-foot ranch-style house was in contract for $155,000 above asking.
The $1.5 trillion tax overhaul President Donald Trump signed in December capped mortgage-interest deductions on loans up to $750,000, down from the prior limit of $1 million. It also set a $10,000 maximum for state and local tax deductions, which were previously unlimited. Those provisions prompted one of the most powerful lobbying groups — the National Association of Realtors — to warn that home prices in some high-end markets would tank.
So far though, those areas have proven to be resilient. There are 308 U.S. ZIP codes that have homes with median values in excess of $1 million — more than 92 percent of them saw their median home prices increase in March from a year earlier, according to data from online real estate database Zillow.
“We are seeing the opposite of what was expected,” said Aaron Terrazas, senior economist at Zillow. “We have certainly not seen the doomsday predictions play out.”
An example of the tax-reform impact on the $1.2-million buyer, who we guessed might be affected the most from the recent tax reform:
Freddie Mac looked at the possible effects of the Tax Cuts and Jobs Act of 2017 in an earlier edition of its Outlook economic forecast. This month it takes that analysis granular – right down to two families, the Smiths and the Johnsons, both in the market to buy a house. The Smiths are a median income family living in Mississippi while the Johnsons are high income earners living in New Jersey. Each family has one kid and each plan to spend four times their income on a home.
The Smiths would see little impact from homeownership under the new tax law.
Their taxable income would decrease from $17,150 in 2017 to $16,000 in 2018 as the much larger standard deduction makes up for the elimination of or caps on many deductions that might earlier been itemized. The Johnson’s on the other hand, see their taxable income rise from $198,908 to $250,904. The Smiths enjoy a $115 reduction in their income taxes while the Johnson’s pay $4,300 more.
Freddie Mac quotes a study by Zillow that found only around 14 percent of homes in the U.S. are “worthy enough” for a new homebuyer to benefit from itemizing deductions; down from 44 percent under the previous tax rules.
But the bottom line is that the new tax law does not stand in the way of the Smith’s homeownership decision, while for the Johnsons the tax savings from owning a home would go from $33,000 to $5,000. Freddie Mac speculated that the Smith family could put off buying a home for longer than if the tax bill had not been enacted.
If the entire amount of the lost tax savings were reflected by the same amount in lower home prices, that would be a 1 percent reduction in the Johnson’s market and much less in other parts of the country. However, economic models usually compare the user cost of housing with renting. If rents remain unchanged, then house prices may fall to reflect higher homeownership costs such as property taxes or higher interest rates. Under the new law higher property taxes would further impact taxes among those who itemize (because of the cap) while higher interest rates would affect everyone.
Freddie Mac concludes that the direct impact of the tax bill will be limited in terms of national house prices. Certain markets with higher average incomes (and thus more households likely to itemize deductions) and property tax rates may see larger direct impacts on house prices ranging as high as around two percentage points. But the largest effect on prices will come through higher mortgage rates, which impacts all households irrespective of tax laws.
Freddie Mac’s economists also reviewed refinancing statistics for the fourth quarter of 2017. Cash-out refinances, those transactions where the new mortgage balance was at least 5 percent higher than the old mortgage, represented 63 percent of the total, down from 89 percent in the previous quarter but still a significant increase from the 44 percent in the 4Q17.
Homeowners cashed out an estimated $14.8 billion in net home equity in 2017 dollars, during the quarter, down from $19.0 billion in Q4 2016. This is a far cry from the $102 billion cashed out at the peak, in the second quarter of 2006.
The average reduction in interest rates enjoyed by those who refinanced first liens in the fourth quarter was 65 basis points. A year earlier the savings averaged 105 basis points.
Freddie Mac said the relatively low rate reduction (the average was 190 basis points in Q2 2013) reflects the high percentage of refinances for consolidating other debt or for home improvements. The average cash out amount over the last few quarters has been around $55,000.
I sent yesterday’s post to Lawrence – and this was his reply:
Home values falling 8% to 12% were based on taking away all of the deductions- no MID and no property tax deductions.
Fortunately, MID is set at $750,000 and $10,000 for state and local tax deductions. With these in place in the final tax bill, we have not said of those price declines. Our forecast is for a 2% price gain nationwide. You, nonetheless, bring a good point that there are still many consumers thinking of what we had said earlier. We’ll work in getting the updated info out more aggressively.
I thanked him for his response.
Are potential home buyers going to bother with calculating the specific impact of tax reform, and then not buy a house if they don’t like the result? Or would they spend less on a house?
Californians are used to heavy taxation. I’m guessing they will shrug off a few thousand more in taxes if it means getting the right home.
For those who want to estimate their taxes, and are WSJ subscribers, here’s a basic calculator:
Yunnie and the National Association of Realtors still haven’t released any math or formulas on how they came up with their conclusions, and it appears he is just shooting from the hip. There is no factual evidence that points to the tax reform causing lower prices and sales – it is theoretical only.
He is the lead voice for the realtor body – and we deserve better.
Lawrence Yun, NAR chief economist, says “Another month of modest increases in contract activity is evidence that the housing markethas a small trace of momentumat the start of 2018. Jobs are plentiful, wages are finally climbing and the prospect of higher mortgage rates are perhaps encouraging more aspiring buyers to begin their search now.”
Added Yun, “Sadly, these positive indicators may not lead to a stronger sales pace. Buyers throughout the country continue to be hamstrung by record low supply levels that are pushing up prices – especially at the lower end of the market.”
NAR says home prices increased over 2017 by 5.8 percent, the sixth year in which the increase exceeded 5.0 percent, blaming an uninterrupted supply and demand imbalances throughout the country for the rapid growth. While tight inventories are still expected to put upward pressure on prices in most areas this year, Yun says price growth will probably shrink, and some states could even experience a decline, because of the negative effect the changes to the mortgage interest deduction and state and local deductions under the new tax law.
“In the short term, the larger paychecks most households will see from the tax cuts may give prospective buyers the ability to save for a larger down payment this year, and the healthy labor economy and job market will continue to boost demand,” said Yun. “However, there’s no doubt the nation’s most expensive markets with high property taxes are going to be adversely impacted by the tax law.”
Added Yun, “Just how severe is still uncertain, but with homeownership now less incentivized in the tax code, sellers in the upper end of the market may have to adjust their price expectations if they want to trade down or move to less expensive areas. This could in turn lead to both a decrease in sales and home values.”
Yun does anticipate a slight increase (0.5 percent) inexisting sales this year (5.54 million), on top of the 1.1 percent increase last year. Single-family housing starts are forecast to jump 13.3 percent to 961,000, which will push new home sales up 15.3 percent to 701,000 (608,000 in 2016).
Pending sales were mixed on a regional basis, with the worst performance in the Northeast where the PHSI fell 5.1 percent to 93.9 in December, and is now 2.7 percent below a year ago. Contract signings in the Midwest were also down, but by a more modest 0.3 percent, dipping to 105.0, but remaining 0.3 percent higher than December 2016.
The other two regions saw contract signings increase; by 2.6 percent in the Southto 126.9, and 1.5 percent in the Westto 101.7. The Midwestfinished the year 4.0 percent above the previous December.
The National Association of Realtors has re-thought their negativity barrage on the tax reform, and is back in cheerleader mode:
While the new tax law is already in effect, here we estimate how home prices will trend in 2018 for each state. The new tax law reduces the limit on deductible mortgage debt and limits the deductibility of the real estate tax up to $10,000. These two provisions are expected to have an impact on the housing market. Moreover, a higher standard deduction may lessen the incentive to purchase a home, as fewer consumers will utilize mortgage interest and property tax deductions.
Aside from the tax reform impact, it is of utmost importance to understand that the current state of the housing market will also influence home prices. Prices are shaped by supply and demand, like any other economic asset. A shortage of supply pushes up prices, while excess supply causes prices to fall. In the past five years, housing inventory has fallen across the country and as a result, home prices continue to rise.
They have broken down their data for each state too.
Here is what they say about California:
In spite of California prices going up 7.9% in the third quarter of 2017, they project a 1.1% increase for 2018 – which is quite a drop-off.
How is their math? Let’s check:
Factor 2 – Tax impact
The average interest paid for a 30-year fixed-rate mortgage:
What? Just a quick look at those numbers and you can sense a mistake. Interest on a $750,000 loan has to be more than $1,200 per month. Thanks to Google, there are several mortgage amortization calculators online, and within 30 seconds I found this:
Even the full interest paid over the life of the loan divided by 30 is more than $15,170 (it’s $17,967 per yr). Then they calculate the impact on existing homeowners, BUT THERE IS NO M.I.D. CHANGE FOR THEM. The new limit of $750,000 is for new home buyers, not existing.
The N.A.R. is publishing articles nationwide, and nobody checks these? If they can’t get their facts right, how reliable is anything they say?
Like my high school baseball coach used to say,
“Don’t believe anything you hear, and only half of what you see!”
In spite of the hysterics presented by those with an agenda, it turns out the tax reform might not be as bad for housing as they thought – at least for those who make less than $20 million per year. From HW:
However, according to two recent expert reports, the devil is in the details.
Thomas Torgerson, co-head of Sovereign Ratings at ratings agency DBRS, said that for most households, tax reform should only have a marginal effect.
“Even in the more expensive metropolitan areas, DBRS estimates that most households with taxable income of less than $400k will see either minimal change or an increase in disposable income,” he wrote in a report today.
“Households with taxable incomes above $400k are likely to experience a decrease in disposable income, though the effects may be muted for households that are already subject to the Alternative Minimum Tax,” he added.
However, things change slightly in areas with higher than average state and local taxes, as well as the more expensive metros in the nation right now. The law caps SALT tax deductions at $10,000, so it’s possible some homeowners may need to move to more affordable areas.
Real estate valuation and data analytics service HouseCanary will soon release the following report: “Will tax reform change your housing plans? Hyper local analysis tells the tale” And in that report, provided early for the benefit of HousingWire’s readers, analysts at HouseCanary dug through mortgages from 2017 between $750,000 to $1 million, to see how many current households would be impacted by the new tax law.
They found, overall, the average estimated household impact in the top 50 MSAs will be $1,950 per year, or $162.50 per month.
According to the Torgerson DBRS report, disposable income is most likely to decline in higher income households with incomes above $400k and particularly above taxable incomes of $1 million, where lower tax rates are more than offset by the expected increase in taxable income due to the loss of SALT deductions.
“In high SALT areas, DBRS estimates the reduction in disposable income is likely to average 3% for taxable incomes between $400k and $1 million, and could exceed 7% at incomes beyond $20 million. However, housing decisions within this income segment are less likely to be constrained by a reduction in disposable income.
Moreover, many of these households are presently subject to the Alternative Minimum Tax.
If the deductibility of SALT is already effectively limited due to AMT, the changes will have less of an adverse impact on disposable income for some of these higher income households. Furthermore, many of these same households should benefit financially from corporate tax changes, either as owners of a pass-through business or simply due to gains already reflected in their stock portfolios.”
It won’t be long before we shrug off what the politicians are doing to us, but first, let’s see what people are saying. The net effect is what future home buyers think about losing the roughly $3,000 in MID tax savings (from the $750,000 cap, instead of $1M) and having to eat the taxation of state, local, and property taxes above $10,000. There could be future sellers who decide not to move also, which would help to offset any decline in demand.
Christopher Thornberg, founding partner with Beacon Economics, predicted prices will keep on climbing in Southern California, given the robust economy and shortage of listings. “If you are borrowing a million bucks to get a home, the write-off is not your primary concern,” he said.
Fadel Lawandy, a director at Chapman University’s Hoag Center for Real Estate and Finance, pointed out that the bill also caps property and state income tax deductions at a combined $10,000 — about $8,500 less than the average deduction taken by Californians in 2015, according to the Tax Policy Center.
Combined with the new cap on mortgage interest deductions, that could mean some households will have less to spend on housing, leading to price declines in some wealthy areas, Lawandy said.
“It will impact the high luxury-end market for sure,” he said.
Chris Lafakis, a director with Moody’s Analytics, said that by adding an estimated $1.5 trillion to the federal budget deficit over 10 years, the tax bill will put upward pressure on interest rates — including mortgage rates, which have remained under 5% for the last six years.
The tax bill doubles the standard deduction, which means fewer households will itemize. That may result in people buying a less expensive house because they couldn’t write off any interest, Lafakis figures.
A Moody’s analysis of a bill that previously passed the Senate — which eliminated the state income tax deduction but kept the $1-million mortgage deduction — estimated that home prices in L.A. County wouldn’t necessarily drop, but would wind up 3.8% lower than they otherwise would be by the third quarter of 2019.
“It is something that will hinder house price growth, but I wouldn’t say it’s going to do much more than that,” Lafakis said. “At the end of the day, we do have a strong economy in California.”
Among those watching the tax debate is Barry Sulpor, a real estate agent who specializes in the South Bay and has his office in Manhattan Beach, where the median home price was $2.26 million in October, according to Zillow.
Sulpor estimated that at least half of his clients take out mortgages over $750,000. He said some sellers are more willing to sell now, because they are uncertain how much longer prices can keep rising and how the tax bill will affect the economy.
Some economists, for example, expect the bill could have a slight drag on growth in high-tax California, even if they expect the economy to keep growing.
Sulpor said he doubts limiting the mortgage interest deduction would put the kibosh on people’s home search, but thinks some people may hesitate to sign a deal. “I think psychologically it could be a big deal, even though it may not practically matter that much,” he said.
Jeff Lazerson, president of Laguna Niguel mortgage brokerage Mortgage Grader, said he hasn’t heard much concern. “People who are bent on buying are bent on buying,” he said.
That includes Jake Schmidt, a client who is looking for a home in Orange County and expects to take out a mortgage for $1 million to $1.2 million.
The owner of an online retail business, Schmidt said he doesn’t know if he’ll pay more or less in taxes on next year’s income. But the uncertainty isn’t deterring his search for a five-bedroom house on a nice street for his children.
“It is not super critical, the pricing or the tax deduction,” said Schmidt, 39. “I am more interested in finding a good house for my family.”
The tax bill also explodes the deficit by $1.5 trillion, resulting in higher mortgage rates, and ultimately weakening housing demand, said Mark Zandi, the chief economist at Moody’s Analytics.
“Considering all of this, the hit to national house prices is estimated to be near 4% at the peak of their impact in summer 2019,” Zandi said. “That is, national house prices will be approximately 4% lower than they would have been if there were no tax legislation.”
Now that the tax reform is happening, what will it means for housing? We already have a natural cycle that has been maturing, and how buyers and sellers interpret the tax reform could exacerbate the issue. It will take healthy employment and incoming retirees to keep the party going!
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