How Will Tax Reform Impact Playa Vista Homeowners?

Unless you’ve had your head in the sand the past few months, you already know that the Republicans recently pushed through tax reform, which will take effect next week. In addition to slashing the corporate tax rate and adjusting the tax brackets, these new laws will change the taxation involved in owning and selling real estate more than other changes in recent memory. These new laws are not beneficial for those who itemize deductions, particularly for markets such as Playa Vista, which are located in a high tax/high cost state where there are a lot of second homes. The effect on some people’s taxes will be noticeable with unknown effects on supply and demand and thus property values. Here are some of the key points:

1. Mortgage interest deduction – Beginning in 2018, this deduction is scaled back to interest on debt up to $750,000, instead of $1 million, for people who buy homes on or after Dec. 15, 2017 who close after January 1, 2018. The deduction will be grandfathered in at $1 million for homes purchased prior to this date. This does impact a large portion of the Playa Vista market as there are a good number of homes over $1M where this reduces the amount that can be deducted. While this sounds like a lot, it should move the meter less than you think. Based on current interest rates, the difference in interest paid on a $750K mortgage vs. a $1M mortgage is about $10,000/year, which comes out to about $3,500 in lost tax savings (depending on one’s tax bracket) per year. Since you still can’t deduct rent and purchasing a home is often about much more than tax savings, this is probably not enough to sway most people’s home purchase decision.

2. Property tax deduction – The former tax law allowed qualifying taxpayers to reduce their taxable income by the total amount of property taxes they paid. Beginning in 2018, the deduction is limited to a total of $10,000 for the cost of property taxes, and state and local income taxes or sales taxes. This does limit the potential deduction since state and property taxes are much higher than $10,000 for most, if not all, Playa Vista homeowners. However, the operative word is “qualifying”. In order to afford the high cost of living in Playa Vista, many homeowners must make enough to be above the AMT (alternative minimum tax) threshold, which limits many of the same deductions. Therefore, these folks may not have been getting this deduction anyway. This will more disproportionately impact the middle class and may encourage many to take the standard deduction instead of itemizing.

3. Mortgage interest deduction for second homes – You may deduct interest on mortgage debt on your primary home and a second home. The new law keeps this part of the former tax law in place, although it reduces the amount of eligible mortgage debt to $750,000 from $1M for second home owners. While the tax savings is reduced similarly to #1, this may have a larger impact on the Playa Vista market since people are often more flexible with second home purchases and therefore may choose a lower cost location if they are sensitive to this reduced deduction.

4. Capital Gains Exemption on Sale Unchanged (whew) – When in discussions, this one worried me. When you sell a house, the capital gain is the difference between the price you paid for it and the price you sold it for. This capital gain is treated as taxable income. If you owned and occupied the home for at least 2 of the last 5 years, you are allowed to exclude up to $500,000 of this capital gain as income so you don’t have to pay federal income tax on it. (The exclusion is capped at $250,000 for married taxpayers filing separately.) The new tax law doesn’t alter the capital gain exclusion for homes, although doing so was in some of the early congressional discussions.

Some of these changes will impact the decision to purchase real estate, the location or price of the property, as well as the decision to potentially pursue alternative investments. In my opinion, this will probably not reduce demand enough to negatively impact the Playa Vista market substantially, but as buyer feedback and behavior materializes, I will provide updates to this post.