The nation’s homeownership rate recently recently rose on an annual basis for the first time in what seems like forever. If this trend continues, it will be swimming upstream against some of the changes brought about by income-tax reform.
Many factors affect homeownership aside from tax policy. They include pride of ownership, stability of location and relatively predictable financial obligations — mortgage payments remain constant over the life of a fixed-rate loan, the most common variety, unlike rents, which tend to increase over time.
That said, taxes play an important role and could slightly erode the argument in favor of ownership, according to a recent paper by the Urban Institute.
Researchers Laurie Goodman and Edward Golding examined the ownership vs. renting question under the new tax rules that, for the most part, kicked in at the start of 2018. They looked at the situation for four hypothetical families earning different incomes under various assumptions. Those assumptions included making a down payment equal to 20% of a home’s value, taking out a mortgage with an interest rate of 4% and enjoying annual housing appreciation of 3%.
The new tax law caps income deductions on large mortgages (those above $750,000 in debt, taken out after Dec. 15, 2017) for people who itemize. It also limits total deductions of state and local taxes, including property taxes, for people who itemize at $10,000 annually. Either or both factors could hurt homeowners from a tax standpoint, especially those with high incomes and large loans.
On the other hand, income-tax rates are dropping for a lot of people, and the standard deduction is rising, helping to offset the loss of itemized deductions.
“While most taxpayers will pay lower taxes, allowing them to save for a home more easily if they choose, the increased standard deduction means fewer taxpayers will itemize,” the researchers wrote. “The reduction in tax rates also suggests less of a benefit for those who do itemize.”
The net result: Renting becomes a bit more attractive on balance.
Still, the researchers don’t expect people to forsake homeownership to rent if they can afford to do both, except at the margin.
“Because homeownership is generally more affordable than renting, and there are other benefits to homeownership … the impact on homeownership rates will likely be small,” they concluded.
The nation’s homeownership rate ended 2017 at 64.2%, continuing a modest recovery from the cyclical low of 62.9% in 2016. But it’s still well below the peak rate of 69.2% that was reached in 2004.
Tax reform also curtailed a key benefit of home-equity loans — the ability to deduct interest on loans taken out starting this year — but plenty of Americans don’t seem to realize this. Just 4% of 1,000 respondents in a survey conducted in late January by financial website LendEDU accurately replied that this benefit has been curtailed.
In fact, one-third of respondents incorrectly thought the tax benefits on home-equity loans improved.
These loans use a home as security or collateral and are fairly popular — in part because they feature lower interest rates than you might pay on other types of loans, especially credit-card balances. In fact, home-equity loans often are used to consolidate other types of higher-interest debt. Tax-deductible interest on home-equity debt was another benefit, at least through last year.
Drawbacks include the fees and paperwork involved in applying for a home-equity loan and, worse, the potential risk of losing your home if you can’t make the payments.
Actually, the new rules on home-equity loans are a bit more complicated than they seem. While interest no longer is deductible if the proceeds are used to consolidate debts or for other non-housing reasons, it can be deducted if the money is used to improve a home substantially, the National Association of Realtors said.
The more things change …
The final tax-reform legislation made fewer changes affecting homeownership than some of the proposals under consideration — and clearly fewer than many in the real estate industry feared.
One significant rule that was left unchanged pertains to capital gains. The legislation retained the ability of homeowners to exclude a portion of their capital gains if they live in their residences for at least two of the five years prior to sale. A proposal would have lengthened that to five years in eight, requiring longer stays for homeowners if they hoped to exclude taxes on housing profits. Up to $250,000 in gains can be excluded for individuals and $500,000 for married couples filing jointly.
Also, mortgage interest generally remains deductible on second homes (up to certain dollar limits), and homeowners may continue to deduct interest on previously existing mortgage debt (as of mid-December 2017) that they later refinance. In addition, some of the provisions affecting rental real estate weren’t altered, such as the ability to make “like kind,” tax-deferred exchanges of rental homes (or other real property) under Section 1031 of the Internal Revenue Code.
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Widening affluence gap
One reason the nation’s wealth gap has widened in recent years reflects rising prices in the stock market and for housing — and the fact that a large swath of Americans didn’t own such assets and thus weren’t able to share in the gains. With home prices and now mortgage interest rates increasing again, affordability could become more of a problem. Over the past year, median home prices have climbed 4%, compared to a household-income gain of 2%.
Prosperity Now, a progressive group in Washington, D.C., sees this as a particular problem for African-American and Latino households. Those groups have average homeownership rates of 41% and 46%, respectively, compared to 58% for Asian-Americans and 71% for whites.
The group said it worries that racial wealth gaps could widen because of economic trends and because of tax reform, which it considers more favorable to affluent households and corporations than to low-income families.
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