The Question of Tax Reform and What It Means for NYC Real Estate
Republicans have recently announced their proposals for an overhaul of the US tax system. Part of this large scale tax reform includes cutting off the ability to deduct mortgage interest and state and local taxes (SALT) from federal taxable income.
As of now, two proposals are currently being debated on. The Senate’s version for tax reform proposes to eliminate SALT deductions but will still maintain mortgage interest reductions. Meanwhile, the House Plan has a partial repeal of SALT but will only allow interest deductions for existing mortgages and new purchases for up to $500,000. This is half of the current $1,000,000 cap that we have today.
Critics of the Republican tax reform effort claimed that this “rehashes Reagan-era trickle down economics.” Supporters, on the other hand, believe that these changes can boost up the economy. Many experts and analysts, however, agree that such proposals will leave a large dent on the wallets of people who lives in places like tax-heavy New York where affordable housing has become a state issue.
Winners and Losers of the GOP Tax Reform
According to GOP lawmakers, their tax reform plans are aimed to reward Americans with massive tax cuts, especially for homeowners, but who are the winners of this tax reform? The consensus is that wealthier taxpayers—those who earn more than $100,000 a year—will benefit the most, especially from key provisions such as the elimination of the alternative minimum tax. On average, New York City’s millionaires would receive a tax cut of at least $113,000. Having more purchasing power in their hands means that they can become even more active players in the city’s luxury market.
Condo developers will receive important gains as well. With the GOP planning to lower the maximum rate businesses are taxed for apartment sale profits—from 39.6% to 25%—condo development becomes even more lucrative than rental development (which retains its 20% tax rate).
Foreigners who invest in real estate will also take advantage of lowered property taxes. Edward Mermelstein, an international real estate attorney and financial advisor to wealthy foreign clients from countries like China, Russia and the UAE, said that they “felt buoyed by the news.”
On the other hand, New York homeowners, especially those who live downstate where property taxes are more than $10,000 annually, would no longer be able to make full deductions, should the GOP plan go to effect. According to New York City officials, more than three quarters of New York City families will pay nearly $5,000 more in income taxes under the proposed bill. In addition, an estimated total of 760,000 families—who mostly make about $75,000 or less yearly-would see tax hikes amounting to $3.7 billion. These possible consequences have also led to concern among the city’s real estate executives.
“I think it has serious implications for this city and for young urban professionals that want to live here and raise families here,” said Maryane Gilmartin, CEO of Forest City.
Stephen Ross of Related Companies also believes that the proposed reform will be a challenge to New York City homeowners, but he also added that the impact won’t be as major compared to the 1980s since taxes in neighboring states like New Jersey and Connecticut are higher today.
A Massive Blow to Affordable Housing
City officials have also argued against the GOP tax plan, especially with regards to affordable housing. Under the proposed bill, tax-exempt borrowing will be highly curtailed which will, in turn, affect city programs including affordable housing and infrastructure projects.
Limited borrowing will also mean that the city cannot refinance bonds at lower interest rates before maturity and the elimination of private activity bonds which the Housing and Development Corporation uses to finance affordable housing projects. The plan may potentially cut off $2.6 billion in annual funding for these efforts, thus putting thousands of middle class homes at risk.
The Effect on NYC’s Rental Market
An estimated 5.8 million tenants will also feel the effects of losing mortgage interest deduction, according to real estate industry experts.
“If this goes on for a few years, it could knock people out of the box in terms of buying a home, especially if you throw in interest rates possibly rising,” Jonathan Miller of Miller Samuel said with regards to the proposed tax reform bill.
With home buying potentially growing even more expensive under the new plan, New York residents may find it more affordable to rent instead. A massive influx of buyers in the market, however, may add pressure to the rental prices of current owners due to increased competition.
Landlords may still continue to deduct property taxes on their rented properties. However, in a city like New York where many landlords reside on the same building that they’re renting units in, they would lose the ability to deduct property tax on the units that they’re occupying. The most likely result is that they would transfer these additional costs to their tenants.
Rising costs in rental, however, can be good news, especially for the developers who would benefit from the higher returns.
Buyer Hiatus in the Market
Ultimately, with the proposed tax bill potentially leading to limitations in property tax and mortgage interest deductions, more and more New York buyers are putting a hold on their plans to make and finalize their purchases.
What could this lead to? One, there would be less revenues from transfer taxes on residential sales due to a decrease in the number of buyers in the market. Two—which is the bigger picture consequence—is that with the massive tax overhaul, there may be more newly built condos, but there will be fewer people who can afford them. Such a scenario can shake up the New York real estate industry to a high magnitude, especially since this could continue to add to its high inventory volumes.
Of course, the proposed bill still lacks some details that GOP lawmakers still need to address. At the same time, the bill will most likely be subject to modifications so that it could gain higher appeal among the American people. In the mean time, both real estate buyers and sellers will continue to monitor for any new developments in the GOP plan which may possibly reach the voting floor by the end of the year.