Renting A Home Suddenly Looks Better Under Tax Reform

As people are working on their tax returns I suspect the reality of the new Tax Cuts and Jobs Act is starting to kick in – and I’m not talking about the withholding/ refund drivel that the media is obsessed with. The bigger issue is the $10,000 SALT (state and local tax) deduction limitation that started in 2018. And, contrary to the popular narrative, this is going to disproportionately hit higher income/ wealthier people. In addition, fewer people will even be itemizing their deductions now that the standard deduction has been increased.
Of course, some clever individuals who read my blog carefully may have taken advantage of a tax hack that I recommended on December 14, 2017 and prepaid the first installment of their 2017 property tax bill before the first of the year. This ensured that they got a good chunk of their 2018 property tax deduction in 2017 when it wasn’t limited. BTW, I regret posting that advice so late in the year and only mentioning it as a side note. But it wasn’t like that was a secret idea.
Anyway, people who took advantage of the property tax prepayment ploy won’t see the full impact of the new tax law on their 2018 tax return but if they look at how the deductions are being limited many will see that they are screwed for 2019. If you already own a home and plan on staying put I’ll actually have some offbeat advice for you next week.
However, if you are contemplating a move you should really revisit the rent vs. buy analysis like you always would. There’s only one problem. Since the new tax law was passed all the rent vs. buy calculators out there (and my favorite has always been the NYT calculator) are wrong. It looks like they all assume 100% deductibility of property taxes and mortgage interest. I know this because none of them ask for the assumptions necessary to do the calculation properly – e.g. SALT deductions exclusive of property taxes and whether or not you even itemize your deductions. Under the new tax law even fewer people will be itemizing now.
So what this means is that whatever answer they give you – which is essentially the answer for the old tax law – has to be adjusted for any loss of the property tax and interest deductions. In other words, owning is now less attractive than it was before the tax law changed. Another way of saying this is that if the calculator shows buying beating renting at 5 years it will actually take longer than 5 years to come out ahead under the new tax law. (I hope I don’t get kicked out of the realtor club for telling you this. I’m obviously a bad realtor.)

Real estate tax deductions
Even if your taxes went down under the new tax law you may be losing some of the real estate tax benefits.

For example, let’s try to put a dollar figure on the impact of losing the property tax deduction. For a household earning $200,000/ year their Illinois income tax would be approximately $10,000/ year, which would totally consume their schedule A SALT deduction under the new tax law. So none of their property taxes would be deductible. If they were to purchase a $625,000 condo their Chicago property taxes would be around $12,500/ year. Their income level is going to put them in a 24% marginal tax bracket, which means that owning a home costs $3000 more per year in federal taxes than what is reflected in the rent vs buy calculators.
You can actually use this information to adjust these outdated calculators for the new tax law. For instance, in the example above the loss of $3000/ year in tax benefits = $250/ month. Just reduce your comparable rent number by $250 and that will offset the phantom tax benefit that the calculator is attributing to buying. If you won’t be deducting either your mortgage interest or your property taxes – e.g. you won’t be itemizing – you can just set your marginal tax bracket to zero. As I said above this is going to move the breakeven date out a bit.
In reality the calculation is even more complicated than I just let on. To really properly factor in the tax benefits of owning a home you would have to look at the tax deductions above and beyond what you would get with the standard deduction. So, if your itemized tax deductions came in at $25,000 then you are really only gaining $1,000 in tax deductions by owning a home.
I actually have a bit more to say on this subject because there are some “creative” things you could do to effectively fully capture the property tax deduction – and they apply equally to people staying put as well as people looking to move. I’ll cover those next Thursday since Tuesday is the Case Shiller home price index update.
#PropertyTaxes #RentVsBuy #TaxReform #TCJA
Gary Lucido is the President of Lucid Realty, the Chicago area’s full service real estate brokerage that offers home buyer rebates and discount commissions. If you want to keep up to date on the Chicago real estate market, get an insider’s view of the seamy underbelly of the real estate industry, or you just think he’s the next Kurt Vonnegut you can Subscribe to Getting Real by Email using the form below. Please be sure to verify your email address when you receive the verification notice.

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