The Tax Cuts and Jobs Act’s Effects on Real Estate, IRAs

The Tax Cuts and Jobs Act, the sweeping tax reform law signed into law last week by President Trump, includes some important provisions for our real estate investor clients, who hold investment properties inside and outside of their real estate IRAs.

Most notably for real estate investors, the new law rolls back the amount of mortgage interest that individuals can deduct for higher-priced personal residences. Prior to the passage of the TCJA, individuals could deduct the interest they paid on qualifying mortgages on balances up to $1.1 million. Under the new law, the mortgage interest deduction on personal residences is capped at $750,000. That’s still much higher than most homes are worth, but some larger homes and homes in more expensive markets will certainly be affected.

The change does not affect mortgages held within real estate IRAs or investment properties. Interest on investment properties is still fully deductible. But it could put a damper on the market for higher-priced homes in general.

An analysis by Zillow found that currently, 44 percent of American homes had mortgage interest payments that were high enough to make it worthwhile for taxpayers to itemize in order to deduct home mortgage interest. After the law takes effect, about 14 percent of them will be in that boat.

Real estate IRA owners, however, will be compensated by much lower taxes on income from traditional IRAs, including real estate IRAs. The same goes for self-directed 401(k)s, SEPs, SIMPLE IRAs and other tax-deferred retirement accounts.

First, your standard deduction is nearly doubling – up to $12,000 for individuals and twice that for married couples. So your first $12,000 or $24,000 of income is tax free.

Furthermore, the tax rates on taxable income are lower. So you pay a lower percentage of tax on income over and above your standard deductions.

The real estate industry hasn’t been entirely happy with the tax cut bill: Moody’s recently forecasted that the law’s provisions would result in 4 percent lower home values by the summer of 2019 than they would have had the bill not passed.  

The culprits? The combination of the cap on mortgage interest deduction, as well as a cap on state and local interest tax deductions that will affect people in high tax states.

That doesn’t mean Moody’s thinks prices will fall by 4 percent. Just that they are likely to rise more slowly than they would have without the bill.

According to Moody’s analysis, most of the negative effects on home values will be felt in pricier markets like San Francisco, Los Angeles and New York.