Potential tax reform and rising inflation may slow down the booming market. Assessing the proposed tax legislation and current market conditions, our crystal ball will help you plan for what’s next.
Right now, trying to predict the impact of federal tax changes on the residential real estate market is a guessing game. “Since no bills have been introduced yet, it’s hard to speculate on some of the effects without details,” says Selma Hepp, Ph.D., Executive, Research and Insights and Deputy Chief Economist, CoreLogic. That said, by assessing the proposed tax legislation in The American Families Plan (AFP) plus current market conditions and possible inflation through the lens of historical market trends, housing economists and Realtors have come up with some solid predictions. Read on for their prognoses regarding various aspects of potential tax reforms.
Increase in Personal Income Taxes and Capital Gains for Higher-Net Worth Individuals
The Tax Cuts and Jobs Act (TCJA) of 2017 reduced the top income tax rate from 39.6% to 37%. Reversing this change (for the top 1%) is a central aspect of the Biden administration’s proposed tax changes, as is ensuring that capital gains are taxed at the same rate as wages (39.6%) for households making $1 million plus.
“There was a real estate boom, and it could end with this type of tax change,” says Daryl Fairweather, Chief Economist at Redfin. “Right now, the housing market is dominated by the wealthy,” she explains. “If we change the structure to tax the wealthy more, they will have less money to spend on real estate and won’t compete as much with middle class buyers.” Investor profits could decrease, as could the rate of home value growth. “Right now, there’s not enough supply,” says Jack Fry, broker-owner of RE/MAX of Reading in Pennsylvania. “However, when demand shuts down and if capital gains taxes increase, investors will find other places to put their money.” On the pro side, though, this type of tax reform could level the playing field for the middle class, says Fairweather.
Reversal of the SALT Deduction Limitation
At this point, the Biden administration has offered no indication that they plan to reverse the $10,000 state and local property and income tax (SALT) deduction cap, which punitively affects states with higher taxes (such as California, New Jersey, and New York). According to Dr. Hepp, “The SALT deduction cap did end up having an impact on sales activity of homes that were on the margin, such as those priced between $1 million and $1.5 million in the Bay Area, as those households saw a material impact on their tax bill and had relatively ‘limited’ income [for that area]. The same could be said for some markets in the Northeast, such as Connecticut.” On the slim chance that the Biden Administration does reverse this deduction limitation, the migration from high to low tax states (such as Florida and Texas) might abate, says Fairweather.
Elimination of Stepped-Up Basis for Gains from Estates
The Biden administration aims to eliminate a provision that allows heirs to rebase inherited assets, thereby avoiding capital gains tax. Specifically, limiting the practice for gains over $1 million ($2.5 million for couples), this could encourage heirs to hold on to inherited homes instead of selling them, says Fairweather, though she doesn’t foresee a major impact on the market.
End of 1031 Like-Kind Exchanges
Moreover, the current administration proposes to end another tax break, which lets real estate investors put off paying capital gains taxes when they exchange one property for a similar property (proposed legislation would apply to gains greater than $500,000). “This would have an extremely negative effect on commercial investments,” says Cathy Kennelly, co-owner and Certified Distressed Property Expert, Signature Realty Associates. “It could be disastrous for a real estate sector that is just starting to recover.” This could encourage investors to hold onto real estate longer instead of selling and buying again, which would reduce inventory at a time when inventory is already reduced, says Fairweather. It could also decrease incentives to become an investor, she adds.
Closing of the Carried Interest Loophole
Many private equity firms invest in real estate — and have been benefitting from a tax break that allows them to reduce capital gains taxes, explains Fairweather. By closing this loophole, such firms might decrease their investment in real estate, which could reduce values of high-end homes and decrease competition for homes, making them more accessible to middle- and lower-income individuals. “Overall, this could be good for middle-class homebuyers who want to live in these homes and not that great for investors and the wealthy,” she says.
The Big Unknown: Inflation
Upping taxes should give some headwind to inflation, says Fairweather, who feels that the price increases we’re seeing are more of a one-time adjustment. As an example, despite the large increase in home prices, there are already signs that housing price increases could slow down, she adds. Plus, wages are rising, which would balance out increasing prices. So, inflation may impact real estate.
Housing has been a relatively good inflation hedge, according to Dr. Hepp. She points to a CoreLogic blog post, which compared home prices with the consumer price index over a long period of time. According to CoreLogic’s Chief Economist, Frank Nothaft, in general, stock market values have grown more than home prices since 1946 and home prices have increased slightly faster than inflation.
While higher inflation would probably increase the rate of home price appreciation, Dr. Hepp continues, it could also mean higher mortgage rates. Indeed, “Inflation can be a double-edged sword,” says Kennelly. “Your house is worth more, but it would cost more to purchase, which could hinder ‘move-up’ buyers. If interest rates trend higher, it would be an additional concern.” Still, she adds, “There is currently strong demand for homes, which could remain for some time due to the huge population of Millennials, who need homes.”
Origination: https://www.realtrends.com/how-rising-taxes-inflation-might-impact-u-s-residential-real-estate/
