What happens to House Prices if Mortgage Interest deduction ends?
Investor / Broker · Brooklyn, NY · Member since 2016 · 665 posts · 1k+ votes
Unfortunately, it seems that this Government wants to take away any kind of Debt Financing of either Business or Home.
It's pretty much in the Republican Tax Reform policy that they are pushing ahead. What's even more concerning is that there is an Opinion piece from the Party's think tank website, the Hill, that came out just recently. It is starting to seem to me that there is a genuine push to eliminate the Mortgage Interest Deduction.
Here is that Article: Time to Eliminate the Mortgage Interest Deduction
I anticipate that if the Mortgage Interest Deduction is taken away for Home Owners, then those investing in SFH will be vulnerable to a price correction.
However, if Debt Financing is eliminated completely, including Corps/Partnerships/Sch E properties.... then the whole RE Market will take a dive.
Just curious if anyone has been following this. It would seem that it's very important but it looks completely ignored.
Investor Llew
The mortgage interest deduction for personal residences makes little difference unless you have a large mortgage. I believe you have to itemize to receive it. Of course, NAR will oppose any such move contesting it will be bad for the RE markets and homeowners in general.
I don't see them eliminating interest expense from business taxes.. if the business is paying interest that is to buy capital and expand, saying that interest expense is not a business expense would be slicing the throat of business expansion, and that is ALL business in the US, not just real estate.
Eliminating the mortgage interest deduction for people would generate some weird stuff (I think). First of all investors (in a business) would be able to pay a higher price for houses than individuals (since business would be able to deduct the interest), though house prices would go down, the cost of owning a house would go up, so there would be a balance there, but I think that there would be a net loss of individuals buying houses and more renting, since the comparative cost of renting would look cheaper to buying.
Then if this happened suddenly (not phased in over some years), immediately the house prices would go down and immediately many people would be underwater in their homes (again) and we would have a crisis.
However, in thinking about this, to be in the same place financially, a person would just have to start an LLC to buy a house, and have that LLC rent it to themselves, and thus the company would be able to deduct the interest... so in the end the only people to gain are the lawyers setting up the LLCs
The interest deduction will have NO impact on sales prices, especially on SFRs. If absolute across the board implementation were to occur, the we would see massive foreclosures again as current owners would have severe impact in their monthly budgets, even if deferred to April 15th where the S*** hits the fan.
The mortgage deduction is akin to social security - - the well know third rail of politics - - touch it and you will (politically) die.
The article you posted is clickbait for "eliminating mortgage interest deduction":
In the article it says "The National Low Income Housing Coalition’s United for Homes campaign calls for reducing the amount of a mortgage eligible for a tax break from $1 million to $500,000—impacting fewer than 6 percent of mortgage holders nationally—and converting the deduction into a credit, allowing an additional 15 million low and moderate income homeowners to get a much-needed tax break."
Trump has been talking about limiting mortgage interest deduction to 100k. Fact of the matter is, this will mostly affect the wealthy.
The mortgage interest deduction for personal residences makes little difference unless you have a large mortgage. I believe you have to itemize to receive it. Of course, NAR will oppose any such move contesting it will be bad for the RE markets and homeowners in general.
Mortgage interest deduction is a perk that helps owner occupied properties. I agree, rocking on it is political suicide for either party. But the removal would shift the financial benefit from owning towards renting a residence, which helps people in the landlord business. It should have no direct effect on landlords with mortgaged properties, since paid interest is a business expense as is maintenance and repair.
If they eliminate the primary residence interest deduction, they will also eliminate it for rental real estate too. They also want to eliminate the 1031 deduction. If they push these through, it will lower the value of real estate. We saw this happen in 1986 when they changed the way depreciation could be taken.
Mark
Here is the Tax Reform page from the Ways and Means Committee for Taxes:
A Better Way Tax Reform Proposal
Here is the Except on Page 26:
"Other Business Deductions and Credits Under this Blueprint, job creators will be allowed to deduct interest expense against any interest income, but no current deduction will be allowed for net interest expense. Any net interest expense may be carried forward indefinitely and allowed as a deduction against net interest income in future years. The benefit of immediate expensing of business investment operates as a more beneficial and more neutral substitute for the deduction of interest expense associated with debt incurred to finance such investment. Allowing investments to be immediately written off provides a greater incentive to invest than is provided through interest deductions under current law; allowing both together would be distortive as it would result in a tax subsidy for debt-financed investment. The elimination of deductions for net interest helps to equalize the tax treatment of different types of financing and reduces tax-induced distortions in investment financing decisions. Providing neutrality takes the tax code out of marginal business decisions, letting market forces more efficiently allocate investment where it is most productive. It also eliminates a tax-based incentive for businesses to increase their debt load beyond the amount dictated by normal business conditions. A business sector that is leveraged beyond what is economically rational is more risky than a business sector with a more efficient debtto-equity composition. The Committee on Ways and Means will work to develop special rules with respect to interest expense for financial services companies, such as banks, insurance, and leasing, that will take into account the role of interest income and interest expense in their business models. Net operating losses (NOLs) will be allowed to be carried forward indefinitely and will be increased by an interest factor that compensates for inflation and a real return on capital to maintain the value of amounts that are carried forward. Carrybacks of net operating losses will not be permitted and the deduction allowed with respect to an NOL carryforward in any year will be limited to 90 percent of the net taxable amount for such year determined without regard to the carryforward."
The Question is will this pertain to all businesses, including Pass Through and sole proprietorship? Or is this only for C-Corp? A friend of a friend cannot believe that their current businesses will lose their Business Interest Deduction and can only offset it by buying another business.
But that's what it seems like is the case.
Maybe someone with better understanding of Taxes, especially with the Republican ideology in terms of Tax Reform can comment here.
Investor Llew
I get suck on this:
The benefit of immediate expensing of business investment operates as a more beneficial and more neutral substitute for the deduction of interest expense associated with debt incurred to finance such investment.
So, you buy a house, or a machine, you get to expense it, as in you spend $100K on a house and you have a $100K expence... so the year you buy the house, you pay no taxes, and you carry that loss forward until you use it up... so assume 7% cap rate (7K of income per year) and you pay no taxes for 14 years..... then what, you would have 0 basis when you sell (since it is all expensed) so selling generates a huge tax bill for you, so people never sell.
So, if you own a rental you essentially get all your tax benefit in the first 10-15 years, then you are stuck with it, unless they change the rules about capital gains....
But then: The Committee on Ways and Means will work to develop special rules with respect to interest expense for financial services companies, such as banks, insurance, and leasing, that will take into account the role of interest income and interest expense in their business models. SO banks and insurance will still get their piece of the pie.. I guess our only hope is that if "Real Estate ownership" is considered "leasing"..
My head hurts, this is a massive change, I need to think about it.
What they are trying to do is stop the trending practice of some of the LARGER Corporations from getting away from paying taxes by moving their headquarters to tax heavens, then "Loaning" the US Subsidiary money, therefore incurring a huge tax deduction, against their US Profits. It's a scheme called "Inversion."
So they think by eliminating the Business Interest Tax deduction, businesses cannot do that and have to rely on their own money. What they call Equity Financing versus Debt Financing.
Really, only the very Rich will see these kinds of benefits.
The middle class or poor won't be able to do this, I believe. But others can comment.
Investor Llew
The mortgage interest deduction for personal residences makes little difference unless you have a large mortgage. I believe you have to itemize to receive it. Of course, NAR will oppose any such move contesting it will be bad for the RE markets and homeowners in general.
John is right (of course:) The interest expense for a married couple must eclipse $11,000+ per year to be of any benefit. That's a huge mortgage at 3-4%! Mine quit mattering years ago.
There are good arguments for getting rid of it if standard deductions are raised accordingly. The finance lobbyists will never allow it, but it is an 'unfair' tax benefit for sure. Only the wealthier (in general) benefit as it stands.
There are good arguments for getting rid of it if standard deductions are raised accordingly. The finance lobbyists will never allow it, but it is an 'unfair' tax benefit for sure. Only the wealthier (in general) benefit as it stands.
What is going to happen to middle class REI people who want to grow there business using leverage? Leverage is a great tool to increase net worth. I am waiting for the next real estate collapse when Trump eliminates the 1031 exchange and the interest deduction. Real estate will only be a rich man's play.
Mark
They are talking about eliminating all deductions but allowing expenses instead. As an investor, you will no longer be required to depreciate the home you purchase...you will take it as an expense the year you purchase it. Then, if you sell it the following year, you will pay a tax on the income of 15% with the only thing offsetting that tax being your actual expenses.
From an investment perspective, I like it. I can continue to buy and accumulate homes and it will work to my advantage (buying a home or two every year). It will be a problem when I decide to sell.
From a personal perspective, it doesn't really make a difference. I've refinanced my home loan at a very low rate, have 7 years left on the note before I own it free and clear, and will be losing my interest deduction within the next 3 years anyway (because the standard deduction is greater than what I would be able to itemize).
It takes a different mindset - folks have been sold for years on the idea that they should spend money in order to save money on their taxes which makes no sense.
@Account Closed
Let's say you buy your property with very little money down so that your Cash on Cash Return is great, say 20%.
However, because the Mortgage Interest is no longer deductible, we have to now add back the Tax that would you have otherwise had deducted because now you will have to pay more tax.
So, if you invested $10k which is $5k down and $5k in closing and renovations, 20% Cash on Cash Return = $10k x 20% = $2k per year.
HOWEVER, because the Mortgage Interest is NOT deductable anymore.... your CoCR is completely reduced taking this into effect.
The 1st year Amortized Mortgage looks like this:
The $5,668 would have offset your Tax obligation. But because we cannot deduct the Mortgage Interest, it will increase your normal tax obligation by $5,668 x 25% (what ever is your tax bracket) = $1,417 more taxes for the first year.
Taking into account the $1,417 HIGHER tax obligation, your real CoCR is $2k minus $1,417 = $583 per year or $583 / $10k = 5.83% CoCR.
Is that really worth it?
Maybe someone else can check my math?
Investor Llew
There has been talk of eliminating the mortgage deduction for many decades, nothing new there. The Realtors and Home Builders will lobby strong to keep it. Already in the law you can't deduct interest on mortgages over $1m. And if the mortgage interest rate would be totally knocked out it would apply only to personal residences and vacation homes, not investment properties. Investment properties have deductions for every expense, check out Schedule E IRS forms for all that is deductible. About the only thin not deductible is the cost of your own personal labor, but all tools, transportation, interest and depreciation are all deductible expenses.
If the mortgage interest was totally eliminated for personal residences if would have a negative effect, but consider it would not affect flippers, landlords, investors, people without mortgages (about 1/3 of home owners) and have little effect on people with small mortgages, and no effect on anybody that takes the standard deduction and doesn't itemize (another 1/3); the impact could be less than anticipated but still negative.
In Bigger Pockets Podcast #82, I talked about how capital gains taxes should be indexed for inflation. Here's another another tax change I'd propose, if you're going to eliminate the deduction of mortgage interest paid for personal residences, then the tax on interest EARNED should also be eliminated. Taking interest earned penalizes people who save, they should be encouraged, and the more money saved, the more money available for lending out, both personally and institutionally.
Hi David. Thanks for responding. In regards to this: "And if the mortgage interest rate would be totally knocked out it would apply only to personal residences and vacation homes, not investment properties." I believe that the link I have in my previous post in this thread shows that the Republican Tax Reform proposes to eliminate ALL BUSINESS INTEREST.
Here is the quote from the Proposed Tax Reform:
"job creators will be allowed to deduct interest expense against any interest income, but no current deduction will be allowed for net interest expense. Any net interest expense may be carried forward indefinitely and allowed as a deduction against net interest income in future years."
My interpretation of this is that you are not allowed to deduct interest on any borrowed money to finance a business, including Real Estate. So that loss gets carried forward unless you can give someone else a loan and deduct that Business Interest against your Business Interest Income. But you cannot deduct Business Interest otherwise.
If you want to read it directly.... click here and go to page 26:
Also, I run a group of Investors that own $15 Million in multi-family Brooklyn Real Estate. I'm very familiar with the Schedule E. What I'm contemplating is that they will just remove the Mortgage Interest Deduction but may allow it to go into an "Unallowed Business Interest Loss" until you can actually use it.
@Account Closed
The 15% tax bracket is for non-pass-through entities.
For pass-through entities, this is the literature in the above link on page 16:
"Millions of small and closely held businesses are organized as pass-through entities – such as partnerships and S corporations – that are taxed under the individual rate structure rather than at the corporate rate. These businesses often compete directly with businesses that are subject to the corporate tax, with the differential in tax treatment creating potential distortions and inequities. As discussed below, the Tax Reform Blueprint will create a new business tax rate for small businesses that are organized as sole proprietorships or pass-through entities, which means that small business income will no longer be subject to the top individual tax rate – not even the lower 33 percent top rate in this Blueprint – thus leading to a maximum tax rate of 25 percent on small business income. This approach to the tax treatment of business income will build on concepts developed by Rep. Vern Buchanan of Florida in his Main Street Fairness Act (H.R. 5076)."
C-Corp tax rates will max out at 15% or 20%. That's because they want to lower the double taxation of C-Corps.
BUT, for entities that do not suffer from double taxation, which are Pass-Through entities like LLCs, S-Corps, Schedule E's... etc. you will pay up to a max of 25%.
At least that's the way i'm reading it.
Maybe we can put our heads together to determine if I'm interpreting this correct AND does this have any serious possibility of passing now that we have both a Republican Congress and a President that may just rubber stamp it?
Also, if they actually pass these Reforms, that may only apply to new businesses AFTER the passage since those of us who have already bought the Investments (or businesses) was not able to write off the purchase of that business in the beginning.
This is going to be REALLY messy.
Investor Llew
@David Krulac I don't think the administration is pushing for removing the mortgage deduction, instead they are raising the personal exemptions. If you raise the personal exemption, the incentive to itemize is gone for people whose homes are priced in the lower price range. Take the example of a 250K home in the midwest, at 4% interest rate that's $8 to 10K interest expense (depending on your down-payment). If personal exemptions go to 30K, then chances your taxes and interest reaching that milestone will be low. Investors and expensive homes will still meet that threshold but i could see the incentive being lost for people who live in low cost areas. Do I think the average joe will notice the difference on his taxes or realize the change ? Possibly not. You would be surprised how many people don't even know which tax bracket they are in. We rely on accountants to do our taxes.
@Account Closed
Ed.... what's really confusing me in your previous posts is when you say the following:
"As an investor, you will no longer be required to depreciate the home you purchase...you will take it as an expense the year you purchase it."
If you are buying a "Home".... you are not allowed to take business deductions like depreciation.
Can you clear up whether or not you are talking about buying a "Home" or an "Investment?"
I think you are not talking about a Home at all but an investment property? You continued using the word home again when you state "I can continue to buy and accumulate homes..." and then here: "I've refinanced my home loan at a very low rate"
I didn't want to make the assumption but would rather you clarify it.
Really.... I'm confused! Please clarify.
As an investor, you buy a home and you depreciate it (generally) over 29.5 years. Under the new rules, my understanding is the proposal will be to eliminate depreciation. If you buy a $150,000 house, as an investor you will have a $150,000 expense in the year you buy it.
As a personal home buyer, I'm saying
1) It doesn't make sense to spend money and buy a home in order to save 25% of what your spending. It makes about as much sense as buying a Ferrari so you can deduct the taxable portion of your car registration on Schedule A of your personal return.
2) Many have refinanced - as in my case down to a 3.5% interest loan. The loan deduction is small...and eventually (in my case) I will not have a deduction for interest because the principal amount of the payment will be much greater than the interest expense and the standard deduction will be greater than an itemized Schedule A
@Llewelyn A. I don't see this happening, especially with a real-estate president in office. The article you cited only talks about capping the deduction for wealthy people, so that is more likely a liberal agenda than a Republican agenda. Ultimately, it would be political suicide to remove this deduction for the middle class and President Trump wouldn't support it. I don't even think a cap would gain support.
Llewelyn A. I think your missing my point in my initial post. Using a 25% tax bracket....in what world does spending $1,000 to gain a $25 benefit make a good investment?
It doesn't. You end up with a $975 loss Every single time.
You can use tax breaks like the mortgage interest expense to benefit you on your personal residence but it makes no sense on an investment property where you can deduct the entire amount.
You are right, but the majority of home buyers believe that having a mortgage to get their deduction is a good tax strategy. I hear it all the time as advice given by banks, tax professionals and real estate professionals. It is more about supporting their own agenda of home refinancing and complicating transactions than it is about investment logic. So, although I totally agree with you, the bulk of the population has a different view based on what they have been told.