What effect will the proposed tax law changes have on Real Estate?

Tax law changes can have a significant effect on real estate prices. As I wrote in What’s Next for the Economy, the 401(k) tax law change in 1988 (sunset clause on withdrawing 401(k) funds for the purchase of a home with no 10% early withdrawal penalty) caused many buyers to accelerate their purchases by the end of that year. Once all the buyers had purchased their homes, the sudden vacuum of additional buyers in the beginning of 1989 and beyond helped accelerate the downward portion of that particular real estate cycle.

The proposed tax reform approved by the House could have a negative impact on housing prices. The House bill proposes to lower the mortgage interest deduction cap to $500,000 from the current $1 million cap. If this change becomes law, those people who purchase “jumbo” loans greater the $500,000 will not get the tax deduction on their tax return for the amount greater than the $500K limit. In effect, this raises the monthly payment by the amount of their effective tax rate.

It remains to be seen what the reconciled bill will look like, as the Senate version of the tax reform legislation retained the $1,000,000 loan cap for the mortgage interest rate deduction. If the reconciled bill retains the $1 million cap, then there should be no effect on the real estate market. However, it should be remembered that tax law changes can and do have unintended consequences, and as the next few months and years play out, we shall come to understand those consequences.