Fear of the unknown had many Illinois residents racing to prepay the first portion of their 2018 property taxes before New Year’s Day, when the GOP tax bill went into effect. How the new legislation is going to impact first-time homebuyers, existing homeowners and the high-end market is weighing on everyone’s minds.
The GOP tax bill — the Tax Cuts and Jobs Act — puts a $10,000 cap on deductions for state and local taxes combined. The mortgage interest deduction has been reduced from $1 million to $750,000. But the legislation nearly doubles the standard deduction from its current levels of $6,350 for single filers and $12,700 for married couples who file jointly.
Will it make up for the loss of deductible property taxes? Only time will tell.
“Before tax reform, we deducted our taxes. It wasn’t a limit that was in effect; it was an equation,” says Sandra Frampton, a broker with @properties in Barrington. “It was the middleman versus the more affluent community. If you pay $20,000, $30,000, $40,000 in property taxes, it will have a huge impact on you not to be able to deduct more than $10,000. It’s a huge difference for a lot of people. For others, it might not make a difference.”
First-time homebuyers have fewer tax benefits and less incentive to transition from renting to owning than they did before, Frampton says. However, she doesn’t think it will stop them from buying homes, citing multiple reports that say rents are projected to increase in 2018. “There is comfort in knowing what your mortgage is going to be,” she says.
Frampton cites the example of one of her clients who wavered right before closing on his first home. Asking questions was the key to making sure his confidence was restored.
“That’s when we reflect back on the house he purchased,” she says. “What are the property taxes? Which category do you fall into? Why are you buying the house?”
The client was buying the house because he and his wife had just welcomed their first child and they were ready to settle down. “The $10,000 limit on deductions will not have as huge an impact on them, because their taxes are well in excess of the $10,000 limit,” she says. Besides, she knows there’s more to buying a house than tax reform; it’s about becoming part of a community.
Still, property taxes can affect a client’s ability to purchase a home. “As part of my conversation with any client, we talk a lot about buyer affordability and how that is affected by home values, interest rates and property taxes,” Frampton says. “One can have a negative or positive impact on the other. For example, in the higher cost and higher property tax areas, we will likely see price declines, especially now as a result of the legislation’s new restrictions on mortgage interest, and state and local taxes.”
Home values fall in 2018
The National Association of Realtors projects a 2.1 percent decline in high-end home values this year, a drop much less significant than the “drastic” dip it had originally expected. That relatively small decrease should mean that homebuyer interest will continue largely unabated.
“If taxes are going to drive you out of that market, you shouldn’t be buying in that market anyway,” says Leslie Struthers, senior loan officer with Guaranteed Rate. “For tax bills that are $10,000, $15,000 or $20,000, it’s not going to change the world. If it does, then buy less and buy in a price range that’s actually responsible for your future.”
Struthers works in the high-end market, specifically with homes that cost from $450,000 to $1.5 million.
“You can’t let the tax tail wag the financial investment dog,” she says. “People who have means continue to spend. That they lose a tax deduction is not going to waver on anything. Buyers buy because they want to invest their money intelligently and to earn appreciation on property. Buyers buy because they want a home, a place that’s theirs.”
Struthers says tax reform encourages investors to enter into the market and bring more money into it, because they can still write off their interest and taxes against their income.
“They’re not dealing with the changes that homeowners are now managing,” she says.
Realistically, tax reform does make luxury homes less appealing. Struthers has noticed a lot of people moving out of state and relocating to Colorado and Florida. “A lot of high-end people don’t want to pay anymore. They want to retire and get rid of big homes,” she says. “I don’t think that’s changed.” She says taxes shouldn’t take up more than 8 to 10 percent of the owner’s mortgage payment.
What tax reform amounts to is a change in finance, Struthers says. “For most people, they’re not going to avoid buying a home because Congress passed the tax bill. It’s for their kids. It’s for the school district. It’s for their future. So they passed the tax bill, and you lose some deductions. At the end of the day, people will always pay for what they want.”
Property taxes cause concern
According to the 2017 Atlas Van Lines Migration Patterns Study, Illinois ranked at the top for outbound moves. Bryce Fuller, a broker at the Glenbrook office of Baird & Warner, doesn’t believe the tax law itself will encourage or discourage people from buying or selling homes. It’s property taxes that get in the way.
“Property taxes in Illinois are out of control,” he says. “Housing is going to become even less affordable and less enticing to people, because they cannot even deduct all of their property taxes if their home is above average-priced. Owning a home in Illinois is becoming unaffordable without the benefits.”
Fuller’s clients are upset about property taxes continuing to increase to cover government expenditures. “They don’t feel like the state is taking steps to try to solve any problems,” he said, referring to the pension crisis. “Now you can’t even deduct all of your property taxes.”
Clients have complained to him that their property taxes have gone up by 30 to 40 percent in one year, and they don’t see the value in their contributions. He understands firsthand, because his own property taxes jumped by $2,500 in 2016.
“Property taxes 100 percent affect a person’s ability to buy a home,” he says. “Property taxes are the single most significant issue with home affordability. You can get different types of loans, different interest rates depending on terms of the loan, but your property taxes are the most difficult thing to change and have the biggest impact on your monthly payments.”
Struthers says people were more angry two years ago when their property tax bills skyrocketed than they are about tax reform: “It just puts salt on the wound.” She is a big proponent of appealing property taxes, noting that homeowners can save time by hiring an attorney.
Struthers also strongly advises against making your primary residence a home that you intend to flip. Instead, she says approach it like you would stocks and hold on to it for at least a decade before selling.
Homeowners have ways to overcome some of the challenges presented by their property taxes. A “dirty little secret” nobody has talked about, Fuller says, is the home equity line of credit: your second mortgage. “None of that interest on the second mortgage is tax deductible. Zero. It used to be. I think you’ll see a large number of refinances in the near future, of wrapping your second mortgage into your primary.”
Fuller advises anyone who’s unhappy with tax reform to become involved in local and state government, and to support the legislators who share their viewpoints.
“Tax reform isn’t good, and it’s going to affect people on a case-by-case basis,” he says. “With doubling the standard deduction, that will take some pressure off, but we don’t know if it’s going to. We really won’t know until people file their taxes next year.”
Emphasizing the idea that homeownership still has many benefits, Fuller also advises planning for your property taxes in advance.
“A lot of people will want to revise how they operate their lives based on next year’s tax liabilities,” he says. “Unfortunately, it takes a little bit of the shine off of owning properties.
“There are not quite as many advantages to ownership as there used to be — but it’s still a better option than renting.”