Earlier this week, we received a letter from a local realtor. She has clients who are hoping to buy our home or one in our area so that they can live near the rest of their family (yes, there are grandkids involved). I’m not going to lie: I thought about selling. We’re homeowners again, after previously swearing off buying in favor of renting (you can read my original story here and my follow-up here) and despite all of the comments, emails and occasional threatening phone calls from folks who read my story, I still believe that home ownership isn’t for everyone.
That realtor letter reminded me that although we talk about homes as investments, the same way that some folks talk about stocks, it’s often the case that some of the most compelling reasons to buy a home are not economic. And thanks to recent tax law changes, some tax breaks are no longer in play, or as significant. Here are eight home ownership-related changes in the tax law that may affect your tax bill:
1. Double standard deduction. The standard deduction amounts for 2018 – before tax reform – would have been $6,500 for individuals, $9,550 for heads of households (HOH), and $13,000 for married filing jointly (MFJ). Now, the standard deduction amounts are $12,000 for individuals, $18,000 for HOH, and $24,000 for MFJ.
So how does that affect homeowners? Home mortgage interest and real estate taxes are only deductible if you itemize on your Schedule A. You typically itemize if your deductions exceed the standard deduction. Higher standard deduction amounts are a good thing for many taxpayers because you get the larger deduction no matter whether you rent, own, give to charity, etc. However, some taxpayers who may have bought a home based on the potential savings from the “extra” deduction (the amount over the old standard deduction amount) no longer have an additional break for spending more: They get the same tax benefit as many other taxpayers.
Traditionally, only about 1/3 of taxpayers claim the itemized deduction. According to the Joint Committee on Taxation (JCT), that number will tumble from 46.5 million in 2017 to 18 million in 2018. That means only about 10% of taxpayers will itemize. Overall, 61% fewer taxpayers are expected to claim itemized deductions in 2018.
So who loses? Taxpayers who bought a little more house than initially contemplated with the idea that they’d simply write off the extra. The boost in standard deduction serves as an equalizer and means that the extra cash outlay won’t necessarily result in a tax break.
2. Caps on the principal for home mortgage interest deductions. Before tax reform, if you itemized your deductions, you could deduct qualifying mortgage interest for home purchases of up to $1,000,000 plus an additional $100,000 for equity debt. The $1,000,000 cap applied to a mortgage on your primary residence plus one other home.
Now, new mortgages are capped at $750,000 for purposes of the home mortgage interest deduction (for mortgages taken out before December 15, 2017, the limit remains $1,000,000). According to data from the Internal Revenue Service (IRS), in 2015, the last year for which complete statistics are available, interest paid was the second largest itemized deduction on individual income tax returns, making up nearly a quarter of all itemizers. The amount claimed in interest deductions was $304.5 billion, but according to the JCT, that amount will drop by $35 billion.
So who loses? In the immediate tax year, taxpayers who bought up, hoping to capitalize on the mortgage interest deduction are those most affected. However, the cap will also hit homeowners who currently own houses near that $750,000 mark: They may be harder to unload in the next few years.
3. Restrictions on deductibility for some refinancing. Under prior law, if you itemized your deductions, you could deduct qualifying mortgage interest plus an additional $100,000 for equity debt. Under tax reform, the deduction for interest on home equity debt, meaning re-fis not related to improving your home, has been eliminated.
The IRS has since clarified that “despite newly-enacted restrictions on home mortgages, taxpayers can often still deduct interest on a home equity loan, home equity line of credit (HELOC) or second mortgage, regardless of how the loan is labelled.” Specifically, the new law eliminates the deduction for interest paid on home equity loans and lines of credit (through 2026) “unless they are used to buy, build or substantially improve the taxpayer’s home that secures the loan.”
So who loses? Taxpayers who borrowed against their homes to finance big purchases or pay down other non-acquisition/improvement debt.
4. Limits for state and local tax deduction. If you itemize your deductions, you can deduct state and local income or sales taxes, and property taxes. As part of the new law, state and local tax deductions remain in place, but the amount that you may claim on Schedule A for all state and local taxes together may not exceed $10,000 ($5,000 for married taxpayers filing separately).
How much does the new law impact taxpayers? The largest itemized deduction for 2015 was taxes paid. Nearly four in ten itemizers deducted taxes paid on their Schedule A, making up a whopping $553 billion in itemized deductions in 2015. According to the JCT, that total is expected to drop by $90 billion.
So who loses? Taxpayers in high-property-tax states like California and Texas, as well as those in high-income-tax states like New York and New Jersey. In some areas, governments are working to find ways to re-characterize tax payments, including variations on state and local charitable funds or trusts which would accept payments from taxpayers in satisfaction of state and local tax liabilities; those payments would then be re-characterized as deductible charitable contributions for federal income tax purposes. The IRS plans to issue guidance on the matter, and has signaled that it will be consistent with “substance-over-form principles.”
5. Goodbye to casualty losses. Before tax reform, taxpayers who suffer an economic loss due to a natural disaster could claim a casualty loss deduction. A casualty loss is defined as the damage, destruction or loss of your property from any sudden, unexpected, or unusual event. That includes a hurricane, flood, tornado, fire, earthquake or even volcanic eruption. A casualty loss does not include normal wear and tear or damage that happens over time, like termite damage.
(You can read more about casualty losses here. You can read more about what didn’t qualify before here.)
As part of tax reform, the deduction for personal casualty losses has been repealed except for those attributable to a federal disaster.
So who loses? Taxpayers who suffer storm or other damage – like the recent EF2 tornado in Pennsylvania – when the storm or event isn’t classified as a federal disaster. In some instances, homeowner’s insurance can mitigate costs but keep in mind that it may not cover all events. For example, your typical homeowner’s insurance generally doesn’t cover damage from rain or flooding.
6. No more PMI. As part of the efforts to revive the housing market, Congress passed a law allowing a tax deduction for the cost of PMI for homes and vacation homes. Under the law, premiums for mortgage insurance (PMI) were lumped together with deductible home mortgage interest on line 13 of Schedule A. The provision expired but was renewed retroactively for 2017. So far, it has not been renewed for 2018.
So who loses? Struggling buyers. In a tough market, buying a house can be difficult. If you can’t afford to put down at least 20% of the purchase price of your home, your lender may want you to pick up PMI. The homeowner pays the PMI but the benefit flows to the lender in the event of a default. Without a deduction for PMI, the process of buying a home is more expensive for some taxpayers.
7. Mortgage forgiveness exclusions fade away. Once a lender writes off any part of your debt – even a mortgage – the amount which is forgiven is reported to the IRS and may be includable as income. In 2007, Congress passed the Mortgage Forgiveness Debt Relief Act (MFDRA) which offered an exception to the rule. Under the exception, qualified homeowners could exclude up to $2,000,000 of discharged indebtedness income attributable to the acquisition, construction, or substantial improvement of a home.
As with PMI, the mortgage forgiveness exclusion provision expired but was renewed retroactively for 2017. So far, it has not been renewed for 2018.
(You can read more about the original provision under the MFDRA here.)
So who loses? Underwater homeowners. Without the mortgage forgiveness exclusion, the amount that is discharged is includible in income – a potential double-tax-whammy. But take heart: In some situations, relief may still be available (insolvency exclusions, for example).
8. No movement on AMT. Okay, this is more of a nod towards inaction than action. The Alternative Minimum Tax (AMT) is a secondary tax put in place to prevent the wealthy from artificially reducing their tax bill through the use of tax preference items. As part of tax reform, many pundits were convinced that the AMT would be repealed, and it was – for corporations. The AMT remains in place for individuals, but the exemptions have been increased. You can see the rates for 2018 here.
AMT only applies if you report certain types of income that receive tax-favorable tax treatment or if you claim some deductions, including high state & local taxes. If these tax preference items apply, you may have to pay the AMT if, after adding back in those adjustments, your income is more than the AMT exemption amount for your filing status. (For more on the AMT, click here.)
So who loses? Middle-class homeowners in high tax states. Most taxpayers are not subject to the AMT: Those at the very bottom don’t make enough to have to pay it, and those at the top already pay a high tax rate. That leaves those in the middle potentially subject to the tax – but only if you claim certain tax preference items.
Keep in mind that, as written, these changes are not permanent. Most are only in place for the tax years 2018 through 2025, so plan accordingly. And if you have traditionally benefited from tax-favored provisions for homeowners, it’s a good time to make sure that your withholding is correct. For more on a tax withholding checkup, click here. To see what the tax rates look like in 2018, click here.