January 10, 2019

The Housing Industry’s $10,000 SALT Tax Deduction Problem

by Anthony Wright

One of the strong undercurrents impacting the housing industry is the $10,000 State and Local Tax (SALT) deduction limitation enacted by the tax reform bill signed into law by President Trump on December 22, 2017.

For taxpayers who itemize their deductions (versus taking the standard deduction), being able to deduct state and local income taxes has been a huge benefit for high-income earners in states with high local and state taxes (e.g., California, New York, New Jersey, etc.). According to the Tax Foundation, taxpayers earning more than $100,000 receive more than 88 percent of SALT deduction benefits.

In 2014, 34.14 percent of New York tax returns included a deduction for state and local taxes. The average size of those New York SALT deductions was $21,038.02. In 2014, 33.86 percent of California returns included a deduction for state and local taxes. The average California SALT deduction was $17,148.35.

When this tax reform was passed, it sent up caution flags in the housing market that the luxury market in these states may be directly impacted by the response of taxpayers who would no longer be able to benefit from these deductions. Over the past few months, I’ve seen proof that these concerns are real and were warranted. Here are three events that have happened leading into 2019 that we should be aware of and prepared to respond.  

  • New home sales in the Northeast tanked. New home sales in the Northeast fell year over year at a rate of 51.3 percent in September 2018. Because of the tax reform bill, homeowners in New Jersey, New Hampshire, Connecticut, New York and Vermont with the biggest per-capita property tax bills will see much bigger tax bills as a result. This market trend is a seismic shift in the new construction market that, along with the increasing demand for entry-/mid-level homes (>$500K), will significantly impact major homebuilders and economic markets in the Northeast.
  • New home sales in Southern California tanked. Higher mortgage rates and overheated home prices hit Southern California home sales hard in September. The number of new and existing houses and condominiums sold during the month plummeted by nearly 18 percent compared with September 2017, according to CoreLogic. That was the slowest September pace since 2007, when the national housing and mortgage crisis was hitting. The median sale price was up 3.6 percent year over year in September, the principal-and-interest mortgage payment on the median-priced home was up 14.2 percent because mortgage rates increased about 0.8 percentage points over that period.
  • Erosion of luxury housing demand. Luxury homebuilding firm Toll Brothers has reported a 40 percent decline in demand in California. It’s the latest evidence of the tax regulation’s impact on the housing market. “The high-price California market, where the number of Toll contracts signed was down nearly 40 percent in the quarter, was the biggest factor in the slowdown of its home sales,” according to The Wall Street Journal. “Homebuilders’ stocks have been beaten up this year, amid news of a weakening housing market. The share prices for Toll Brothers and Lennar Corporation, the country’s largest homebuilder, are both down more than 30 percent year to date.”
These reports are just some of the early signs. If you’re active in these luxury home and remodeling markets, be prepared to respond to a potential shift in demand as we move further into 2019 and get closer to tax season.

What does it mean? I believe this trend will lead to a few things:
  • Slower growth (if not decline) in new luxury home sales
  • Tighter margins as homebuilders focus demand on move-up and entry-level homes
  • Shifting of demand as homeowners decide to look for lower tax markets and more favorable places to invest the housing dollars
I’ll be looking for these knock-on effects as we move into spring and tax-filing season. What are your concerns about the luxury markets in these states? I’d love to hear from you. Contact me directly at Anthony.Wright@Quanex.com

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Posted: January 10, 2019 by Anthony Wright Filed under: housing, market, trends