Let’s finish off our discussion of how the Seattle-area real estate market may be affected next year by the changes to the tax code. In yesterday’s post we discussed the doubling of the standard deduction, and concluded that it is likely to have very little effect. Today let’s look at the other two big changes: The reduction of the mortgage interest deduction cap from $1M to $750k and the capping of local sales, income, and property tax deductions at $10k.
The limit on the maximum amount of mortgage interest that can be deducted has been reduced from a loan amount of $1M down to $750k. A home buyer would have a loan of around $750,000 if they purchased a home priced about $950,000 with a 20 percent down payment.
To get an idea of how many home buyers is the new limit is likely to affect in the Seattle area next year, I pulled down some sales stats for the last six months from Redfin. Here are the total sales of single-family, condos, and townhomes over the last six months, and the sales over $950k.
| Region | Total Sales | Sales $950k+ | Percent |
|---|---|---|---|
| Seattle | 7,449 | 1,205 | 16.2% |
| King County | 23,555 | 3,595 | 15.3% |
| Snohomish County | 8,700 | 209 | 2.4% |
| Pierce County | 10,900 | 110 | 1.0% |
As you can see, the new limits are not likely to have much effect at all in Sonohomish and Pierce counties. Even in King County and Seattle, the vast majority of sales come in under the limit.
In order to afford a $950,000 home, your income would need to be around $180,000 at a minimum, which puts you well within the 24 percent tax bracket. The interest paid in the first year of a $750,000 30-year mortgage with a 3.9% interest rate comes to around $29,000. Any amount over that is not deductible, so the maximum tax benefit from the mortgage interest deduction is around $6,960.
Prior to this change, the limit was already $1 million. The interest paid in a year on a $1 million home comes to around $38,682, which would be a tax savings of $9,284. So the biggest difference here is a loss of up to $2,324 in tax savings for people probably earning $200,000 or more.
In other words, we’re talking about around fifteen percent of home buyers in King County paying around one percent of their income in additional taxes. Will this have some effect on the housing market? Sure, probably. But given the fact that over 90 percent of Puget Sound home buyers will be completely unaffected, I doubt the difference will be very noticeable.
Finally, let’s look at how the $10,000 limit on state income tax, sales tax, and property tax will affect us.
According to an article in today’s Seattle Times, the average taxpayer who itemized their taxes in Washington state deducts about $2,650 in sales taxes. Since we have no state income tax, that leaves $7,350 in property taxes that can be deducted before hitting the cap. With the average effective property tax rate in King County at around 1 percent, that means that anyone with a home worth more than about $735,000 will start to hit the limit. Around 28 percent of homes sold in King County in the last year (4,488 out of 15,840) sold for $750,000 or more, so it’s probably safe to assume that about a quarter of home owners in King County will bit hit by this limit.
Here’s a look at how a buyer making around $180,000 and in the 24 percent tax bracket (previously in the 28 percent bracket) would be affected by the combination of the lower mortgage interest deduction limit and the $10,000 local tax deduction limit. The table below looks at the tax savings in 2017 and 2018 from deducting mortgage interest and state sales+property taxes.
With just the standard deduction (which doubles in 2018) and personal exemptions (which go away in 2018), a married couple earning $180,000 a year would pay around $31,500 in 2017 and around $26,250 in 2018. So before we even look at the changes in the deduction limits, it’s important to keep in mind that the new tax brackets and standard deduction changes are saving them $5,250 right up front.
| Home Price | 2017 MID | 2017 Sales+Prop. | 2017 Total | 2018 MID | 2018 Sales+Prop. | 2018 Total | Difference |
|---|---|---|---|---|---|---|---|
| $750,000 | $6,500 | $2,800 | $9,300 | $5,550 | $2,400 | $7,950 | -$1,350 |
| $1,000,000 | $8,500 | $3,500 | $12,000 | $6,960 | $2,400 | $9,360 | -$2,640 |
| $1,250,000 | $10,750 | $4,200 | $14,950 | $6,960 | $2,400 | $9,360 | -$5,590 |
| $1,500,000 | $10,750 | $5,000 | $15,750 | $6,960 | $2,400 | $9,360 | -$6,390 |
| $2,000,000 | $10,750 | $6,250 | $17,000 | $6,960 | $2,400 | $9,360 | -$7,640 |
It’s not until a home price of around $1.25 million that the difference starts to exceed the baseline savings from the new brackets. So if our hypothetical couple buys a $2 million home, the net effect of the tax changes in 2018 will be a bump up of about $2,390 in their taxes. Again, about one percent of their income.
In short, I doubt that the changes will have much effect on Seattle-area home buyers at all. Yes, a few wealthy home buyers will see slightly higher tax bills next year, but for the vast majority of home buyers and existing home owners, the changes will have zero effect.