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Throughout the contentious 2016 presidential race, then-candidate Donald Trump promised an overhaul of the United States tax system. He articulated a streamlined tax code with fewer income tax brackets, reduced rates, and a purge of several taxes altogether. At first glance, these campaign pledges seem to promise a boon to the national real estate market, with more money in the pockets of taxpayers leading inevitably to additional spending. These tax breaks, however, are likely to produce unintended consequences that will reverberate throughout the real estate industry.
One of the primary goals of President Trump’s tax plan is to simplify the personal income tax system. Eliminating the Alternative Minimum Tax (AMT) and the 3.8% net investment income tax (NIIT) on net investment income aims to keep money in taxpayers' pockets. The proposed adjustments to individual income tax rates are twofold: a decrease in the number of income tax brackets from seven to just three, and a reduction of the highest income tax bracket from 39.6% to 35% (it is not yet known how the new tax brackets will be shaped). Moreover, the removal of existing AMT or NIIT liabilities for those in the highest tax bracket produces an even more substantial tax savings. However, these simplifications are accompanied by a proposed modification of Schedule A and its itemized deduction calculation. The removal of real estate property tax deductions, currently uncapped, unquestionably reduces the tax benefits of home ownership in both low- and high-property tax locations. This is depressive to real estate sales in markets where local funding is heavily dependent on property taxes, and also for those taxpayers who pay significant property taxes.
Meanwhile, mortgage interest deductions would remain intact. However, the standard deduction is expected to almost double for a married couple filing jointly, from $12,600 (in 2016) to $24,000. While this proposal appears to create the potential for significant tax savings, this same married couple would now have to pay more than $24,000 of interest on a mortgage to itemize deductions (assuming no charitable donations are made). Since most homeowners pay mortgage interest under this new standard deduction threshold, existing homeowners and potential homebuyers would no longer see the payment of mortgage interest as an inherent tax advantage to home owning. Consequently, high-income taxpayers would still be taxed at 35% and may no longer have the benefit of mortgage interest, real estate and state income tax deductions to offset taxable income. Despite the intended objectives, minimal tax benefits for the majority of taxpayers could result.
Another major focus of the Trump administration is to slash the highest corporate tax rate from 35% down to 15%. This aims to create new business ventures, assist small businesses, and to entice companies overseas to relocate to the United States, thus generating countless domestic job opportunities. It is important to consider how this will affect the real estate market. The affordable housing market depends on private investment to fund property development. In return, attractive dollar-for-dollar tax credits are claimed (subject to passive loss rules for individuals). The new corporate tax rate eliminates the benefits that accompany low-income housing development, as the tax credit becomes worthless. This could suppress the low-income housing market, and will likely cause a repricing of both existing development deals and projects currently in their early stages.
Finally, President Trump plans to repeal the federal estate tax, which is a topic of long-standing debate. While many individuals make charitable donations for solely philanthropic reasons, there is also a resulting tax benefit. Charitable giving is deductible from the gross estate at a dollar-for-dollar rate. Repealing the estate tax would adversely affect charitable giving upon death, as there will no longer be a tax incentive to make charitable donations.
All Americans await the looming tax code changes envisioned by the Trump administration. We can only speculate as to how the real estate market will be affected, but for now, it is safe to say that unintended consequences will be pervasive.
To download our exclusive tax reform report highlighting 6 key findings that taxpayers should be aware of in 2017 and beyond, click here.