Although much of the furor over the proposed tax reform plan from the Republican-led House has focused on the reduction to the cap for the mortgage interest tax deduction, it is the proposed changes in capital gains that may make the biggest difference.
In fact, Mark Zandi, chief economist at Moody’s Analytics, told The Chicago Tribune that the tax changes could reduce prices in the most expensive markets by 10 percent.
Price escalation has slowed over the past couple of years, and CoreLogic has reported that over one-third of the top 100 markets are overvalued, so this may be part of a larger correction.
Boon or curse?
For the ultra-luxury market (the $10 million and up range), the tax plan is a boon.
Buyers who can afford that price point are usually business owners or those with inherited wealth. They will likely benefit from the low corporate tax rate and pass-through rates from S Corps and LLCs.
The tax plan from the House also follows through on President Trump’s stated goal to eliminate the estate tax as much as possible.
The bill doubles the basic exclusion amount for gift and estate taxes and repeals the estate tax in six years. Down the road, this could have a phenomenal impact on the distribution of wealth, further fanning demand for homes in excess of $10 million.
For the immediate future, it’s the capital gains changes that will have the greatest reverberations.
Currently, homeowners are allowed to exclude up to $250,000 in capital gains ($500,000 for married couples) when they sell a primary residence.
The existing rule states that owners must have lived in the home for two of the last five years of ownership. The new plan would require that the homeowner must have lived in the home for at least five out of the past eight years.
The changes also allow one sale every five years instead of every two. The exclusion is also diminished by a dollar for every dollar a joint taxpayer’s adjusted gross income exceeds $500,000.
The markets that will be most strongly impacted are those in the Northeast and on the West Coast.
In some of the areas, where luxury properties have already lingered on the market, many sellers may opt not to sell after all.
In markets such as San Francisco, the combination of high prices and low affordability have already taken a tremendous toll; the proposed tax plan may create added stress on the region.
In places like New York where property taxes are high, the part of the plan that would cap the property tax deduction at $10,000 would also have a big impact.
Jerry Howard, CEO of the National Association of Home Builders, told USA Today that “3.7 million households paid more than $10,000 in property taxes in 2016.”
Our predictions
What the tax bill will do is provide new constraints and considerations as people begin to contemplate making their next moves.
What we may see in the short term is a bit of a seller stampede as sellers try to sell now and maximize their profits.
For example, if buyers purchased a home for $1 million and then had a $1.25 million sale, they could see nearly half of their profit out the door in taxes and fees.
In the long term, the proposed changes could also affect how owners feel about commissions. The middle of the market is where taxpayers will get squeezed the most, and that is also where agents make the biggest chunk of their earnings.
With a smaller piece of the profits from each sale going back to the seller, every percentage point will be up for debate.
It’s too soon to know whether the proposed tax reform will successfully make it through the legislative process, but at this point, all things point to a more favorable environment for the very high-end and uncertain times for most American homeowners and the real estate community.
Chad Roffers is the chairman of international luxury real estate company Concierge Auctions. Follow him on Twitter.
