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The new tax law raises issues about the housing market in high-tax states issues that your clients may want to consider. Should they buy a new home or rent? Consider selling their current home sooner or later?

The law’s limits on deductions for mortgage interest and state and local taxes coupled with the almost doubling of the standard deduction, decline in marginal tax rates and higher thresholds for income subject to the alternative minimum tax can affect “the after-tax cost of mortgage interest and property taxes,” according to a new report from the Federal Reserve Bank of New York.

Those effects, in turn, can ultimately affect decisions about buying or renting a home and when to sell for residents in high-tax states, according to the report, “How Will the New Tax Law Affect Homeowners in High Tax States? It Depends.”

(Related: NY Governor Proposes Tax Changes to Offset Federal SALT Deduction Cap)

New York Fed researchers looked at the overall federal tax liability and marginal after-tax cost of mortgage interest and property taxes for a range of hypothetical recent homebuyers in a high-tax state, namely New York, using the old tax code and new tax code. Household income and home values were divided into nine groups, ranging from $50,000 to $1 million for income and $163,000 to $3.25 million for home values.

Researchers made the following assumptions:

  • Home purchase price was 3.25 times the couple’s adjusted gross income
  • Mortgage was 30-year fixed with a 4.5% interest rate and equal to 80% of the home price
  • Property taxes equaled 3% of the home’s value
  • Property insurance equaled 0.4% of the home’s value
  • Monthly payments for mortgage principle and interest, property taxes and insurance equaled 27% of the couple’s AGI

They did not factor in other changes in the new tax law such as the expanded child tax credit.

(Related: 4 Last-Minute Tax Strategies for Clients in High-Tax States)

What they found were substantially different results, depending on whether the household would still itemize deductions or take the new, larger standard deduction; was still subject to the AMT; or subject to the new local caps on the mortgage interest deduction (up to $750,000 of mortgage debt) or new limits on the state and local income tax deductions (now $10,000).

Estimated effects of tax reform on recent homebuyers in New York state. Source: Federal Reserve Bank of New York. Source: Richard W. Peach, Gizem Kosar, and Nicole Gorton, “ How Will the New Tax Law Affect Homeowners in High Tax States? It Depends,” Federal Reserve Bank of New York Liberty Street Economics (blog), April 11, 2018. Used with permission.

Households in the $150,000 to $200,000 income range with home values ranging from $325,000 to $650,000 would likely continue to itemize deductions, but because of the $10,000 limit on state and local tax deductions they would experience a 15% increase in the marginal after-tax cost of mortgage interest and property taxes and an increase of nearly 10% in federal tax liability, according to the researchers.

In contrast, households with an AGI in the $300,000 to $800,000 range, who will also continue to itemize, will likely not see an increase in federal tax liability because they would not be subject to the AMT, but at the lower end of the range they would be subject to the new, lower limit on the mortgage interest deduction.

Although the after-tax cost of an additional $1 worth of property taxes won’t change from when they were subject to the AMT (which would disallow some property tax deductions), the lower cap on the mortgage interest deduction (now $750,000 instead of $1 million), they would see an increase in the marginal after tax-cost of mortgage interest and property taxes.

“Theory suggests that such increases will affect the behavior of prospective homebuyers, potentially weighing on both home prices and the homeownership rate,” the researchers report. “The exact magnitudes of such impacts are uncertain, however, because the marginal after-tax cost is only one of many factors influencing homebuyer behavior.