Winners and Losers
There is a new tax code in town. It redistributes and, in some cases, reduces Federal tax burdens among regions, market sectors, and individual taxpayers. The bill reduces the value of long-standing tax preferences for most homeowners in expensive real estate markets. Perhaps more damaging to State’s economy, the new rules reduce or even eliminate the deduction for state income taxes. To add further insult, Congress reduced the maximum mortgage amount on which interest can be deducted to $750,000.
There is no good news for Californians who live in neighborhoods with above average housing prices. I think most credible economists would argue the nation’s tax burden has been shifted from poor states to rich states. About 25% of taxpayers will have a tax increase next year and I suspect that percentage will be far higher in San Diego’s pricey metro neighborhoods.
As an offset, Congress raised the income threshold of the dreaded Alternative Minimum Tax and lowered individual tax rates. Unfortunately for the coastal elites, the value of these two tax reductions will be swamped by the loss of the state and local tax deductions. The net losers will be people making over $200,000 a year with a home in the coastal belt.
The party in power argues lower corporate, personal, and business taxes will spur enough economic growth to offset the negative effects of these selective (and targeted) tax increases. Whether or not you agree with the ‘trickle down’ school of economics, there are strategies one can follow to limit the damage if you find yourself on the wrong side of this new tax code. (First a disclaimer; I am not giving any financial advice in this column, consult the appropriate professional for tax and investing advice.)
This is the third major tax cut in recent memory and the past can provide some useful guidance. In 1981 and 2001 rates were lowered, particularly benefiting those in high tax brackets. No credible economist believes the two experiments worked in the long term, money did not find its way down the economic food chain. The only tangible result was a swollen national debt; it was 1/20th the size of today’s debt in 1980. Critics of tax reform say the corporate tax savings will not be invested in job-creation enterprises. They argue the windfall will go to executive bonuses, stock-buy-backs, business debt reduction, and offshore accounts. I could not help but note that AT&T raised their dividend within days of this bill being passed, even though analysts noted the corporation’s earnings did not justify the increase.
Never fight the tape; there are some things you could do. First, I am moving equity from my investment real estate portfolio into stocks. In my opinion, all of this new cash floating in the hands of our economic betters has to land somewhere. Bond yields are very low and appreciation prospects poor. The bull market in commercial real estate is long in the tooth and what is for sale is quite pricey. Interest rates paid by banks will increase next year but not by a meaningful amount. That leaves stocks as the best option, Wall Street is going to have a very good year.
Second, If you a looking to buy an expensive home this year, you should have a easier time of it. In my opinion, there will be some weakness in the market for homes priced over $1,000,000. There will be fewer buyers financially able to purchase properties in that price segment even though home inventories will remain on the low side.
Third, the additional value of Mills Act status will rise dramatically in 2018; having artificially low property taxes will negate some of the ill effects of the new tax code. Those with Proposition 13 taxes may postpone trading up and decide to wait until they reach their 55th birthday, exacerbating the supply problem.
Last, the price of mortgage money will continue to increase as the economy is running at close to full capacity. If the GOP’s rosy view of future economic growth does not pan out, Federal borrowing will put increased pressure on interest rates in 2019 and after.
To conclude, certain real estate market segments will not have a prosperous 2018, but overall I think prices will moderately appreciate. The new tax laws will affect everyone differently and the sky is not going to fall. Best to think of it as a game of financial paintball, be ready to duck.