Ep.37 - Adulting101 - Looking to Buy A Home in 2018? There Are No More Tax Benefits Unless Your House Is Over $500K (3 Minute Read)
Read Time: 3 Minutes
The "comprehensive" tax reform is here. It impacts many aspects of our lives. Out of all, it impacts millions of millennials who aspire to become homeowners in the upcoming years. Before the tax reform, the tax benefits (mortgage interest and property tax deduction) had been a strong incentive to make home buying cheaper.
Well, that won't be the case anymore. Trump's tax reform has completely eliminated tax incentives for millennial homebuyers, whose price range is under $500k. Here is why.
WHAT ARE THE TAX CHANGES IMPACTING FUTURE HOMEOWNERS?
There are three changes:
Standard Deduction: For married couples, the standard deduction increases from $12,000 to $24,000.
Mortgage Interest Deduction: Max mortgage capped at $750k, which means the interest deduction maxes out around $31k at the current mortgage rate of 4.25% (Jan '18).
Property Tax Deduction: Capped at $10k.
TO ITEMIZE OR NOT TO ITEMIZE, THAT IS THE QUESTION
The only way to realize the tax benefits from purchasing a home is through mortgage interest deduction and property tax deduction. And the only way to deduct those two is to itemize your deductions, as opposed to using the standard deduction. In short, you will only receive the tax benefit if you itemize. Now the real question becomes, will your itemized deduction be higher than the new standard amount of $24k? The answer is no, if you are looking to buy a home under $500k.
What if you don't itemize? Then your taxes are the same whether you buy a house or not.
TAX REFORM ONLY BENEFITS HOMES BOUGHT BETWEEN $500K AND $830K (ASSUMING 10% DOWN)
Below are the scenarios with 7 houses ranging from $450k to $1.5M. There are a few assumptions: 1) Mortgage rate is calculated at 4.25% for 30 year fixed. 2) A 10% down payment is applied for all scenarios.
If you buy a house that's less than $500k, you will basically see no tax benefits at all. This is because your itemized deductions (mortgage interests + property tax), are lower than the standard deduction of $24k. For example, in the first scenario with a house of $450k, your total itemized deductions come out to be $22,480, about $1,500 lower than the new standard deduction. As a result, you will take the standard deduction, which means you will pay the same amount in taxes had you not bought the house.
If you buy a house that's between $500k and $830k, you will see a gradual increase in tax benefits as the house gets more expensive. If you are buying a house that's over $500k, your itemized deductions will be higher than the standard deduction, meaning you should itemize. For example, if you buy a condo of $500k in Los Angeles, your itemized deductions are $978 over standard deduction. It seems good, until you realize how much people were getting before this change. Before the tax reform, the same house would've given you $12,978 in additional tax deductions. In fact, no matter the house price, all future homeowners will be getting a smaller tax deduction than before the tax reform.
If you buy a house over $830k, you will NOT see any additional tax benefits. In the $1M home scenario, you would’ve received a whopping additional $38k in deductions before the reform. After the tax reform, your additional tax deductions max out at $17k , because the mortgage interest deductions are capped at $750k, and property tax deduction is capped at $10k. If you live in L.A, you pretty much hit both ceilings when you a buy a house at $830k
THROUGH THE EYES OF TWO FAMILIES - Young&Hitched And HustleCouple
According to the National Association of Realtors, 79% of millennial home buyers were couples (66% married, 13% unmarried) in 2017. For that reason, I will only illustrate the tax impact on homeowners through the lens of two couples: Young&Hitched and HustleCouple.
Impact on Young&Hitched:
- Max Benefits in Actual Dollars Under New Law: $3.8K when they buy a house at $830k. It would've been $7.3K under the old tax law.
- Biggest Loss: The biggest loss is on expensive homes. With a $1M home, Young&Hitched would’ve received $9.5K back, instead of only $3.8K, merely 40%.
Impact on HustleCouple:
- Max Benefits in Actual Dollars Under New Law: $4K when they buy a house at $830k. It would've been $8.2K under the old tax law.
- Biggest Loss: The biggest loss is also on expensive homes. With a $1M home, HustleCouple would’ve received $10K back, instead of only $4.2K, merely 40% of what they would’ve received before.
HOW TO MAX OUT THE TAX BENEFITS UNDER THE NEW TAX REFORM?
The best strategy is to buy a house as close to $830k as possible. This is assuming you put 10% down. The reason is that at this price level, you will hit the ceiling on both mortgage interest deduction of $750k and property tax deduction of $10k. But a $830k home is unrealistic for 99% of millennial first-time homebuyers. If you are looking to buy under $500k, you should embrace the fact that you can't count on any of the tax incentives people have benefited from in the past.
What if you are the 0.1%, who wants to buy that $1M home? The only way is to put down more cash. If you can put down $250k in cash, and borrow $750k, you can still receive the same amount of benefit in mortgage interest deductions. However, you won't be able to deduct all of your property tax, because of the $10k cap.