Tag Archives: deduction

Tax Reform and Home Equity Loans

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photo by Kalmia

MortgageLoan.com quoted me in Tax Reform Just Made Home Equity Loans A Lot Less Attractive. It reads, in part,

Home equity loans have long been attractive ways for homeowners to borrow money to pay for everything from major home improvements to a child’s college education. But these loans just lost a major benefit: When filing their income taxes, homeowners can no longer deduct the interest they pay on home equity loans each year.

This might make these loans less popular. The loss of the interest deduction might persuade homeowners to look for other ways to tap the money in their homes.

“From what I see, there are very limited times that home equity loans would still come in as a benefit,” said Tristan Ahumada, a real estate agent with Keller Williams Realty in Westlake Village, California.

A rush to pay off home equity loans?

And she’s not alone. Donald Daly, managing partner of REIS Group LLC in New York City and a licensed real estate appraiser, said that since January 1 he has seen a higher level of requests for appraisals from homeowners seeking to refinance their existing mortgage loans. Many of these owners are doing this as a way of paying off their Home Equity Lines of Credit, a form of home equity loan.

The reason? These lines of credit, better known as HELOCs, are not nearly as attractive to homeowners when they don’t come with the bonus of a tax deduction.

“We fully expect this trend to grow over the next weeks and months as more and more homeowners learn of the effect these changes will have on their personal finances,” Daly said.

Goodbye, deduction

In the past, homeowners who took out home equity loans or HELOCs could deduct the interest they paid on up to $100,000 of these loans. If you took out a home equity loan for $50,000, then, you could deduct all the interest you paid during the year on that loan. If you took out a home equity loan for $150,000, you could deduct the interest you paid on the first $100,000 of that loan.

When Congress in December of last year signed the Tax Cuts and Jobs Act into law, this all changed. The big tax reform legislation eliminates the home equity loan deduction starting in 2018. You can still claim your tax deduction when you file your income taxes in April of this year. That’s because you’re paying taxes from 2017.

But you won’t be able to claim the home equity loan deduction when you file on your 2018 taxes and beyond. Most of the tax cuts impacting taxpayers, including the home equity deduction rules, are scheduled to expire after 2025. No one knows, though, whether Congress will vote to continue them past that date once that year rolls around.

Existing loans aren’t grandfathered in, either. If you took out a home equity loan in 2016 and you’re still paying it off this year, you won’t be able to deduct any interest you pay on it in 2018, even if you’ve already deducted interest payments in the past.

*     *      *

Home equity loans can still work, though

Just because the tax benefits of home equity loans are disappearing, though, doesn’t mean that these loans are no longer a viable option for all homeowners.

The deduction was a benefit, but the biggest advantage of home equity loans is that they are a relatively cheap way to borrow money. The mortgage rates attached to home equity loans tend to be low. That isn’t changing.

So if you do have equity in your home and you want money to help pay, say, for your children’s college tuition, a home equity loan or HELOC might still be a smart move.

“While tax deductions are important, they are not the only reason we take out home equity loans,” said David Reiss, professor law at Brooklyn Law School in Brooklyn, New York.

Reiss said that when considering whether a home equity loan or HELOC is right for them, homeowners need to ask several important questions.

First, why do they want to take out the loan? If it’s for home improvements or to reduce high-interest-rate debt, the loan might still be worthwhile, even with the tax changes.

Next, homeowners need to look at their monthly budgets to determine if they can afford the payments that come with these loans. Finally, homeowners should consider whether they can borrow money cheaper somewhere else, taking the loss of the deduction into consideration.

“If you are comfortable with your answers, there is no reason not to consider a home equity loan as a financing option,” Reiss said.

The Impact of Tax Reform on The Real Estate Sector

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photo by Sergiu Bacioiu

Congress passed the tax reform act on December 20, 2017 and President Trump is supposed to sign it by the end of the week. A lot of ink has been spilled on the impact of tax reform on homeowners, but less on real estate as an investment class. It will take lawyers and accountants a long time to understand all of the in ands outs of the law, but it is pretty clear that commercial real estate investors will benefit significantly. Most of the provisions of the act are effective at the start of the new year.

Homeowners and the businesses that operate in the residential real estate sector will be impacted in various ways (the net effect on any given taxpayer will vary significantly based on a whole lot of factors) by the increase in the standard deduction; the limits on the deductibility of state and local taxes; the shrinking of the mortgage interest deduction; and the restrictions on the capital gains exclusion for the sale of a primary residence. There are tons of articles out there on these subjects.

The impact on real estate investors has not been covered very much at all. The changes are very technical, but very beneficial to real estate investors. There are a couple of useful resources out there for those who want an overview of these changes. The BakerBotts law firm has posted Tax Reform Act – Impact on Real Estate Industry and the Seyfarth Shaw law firm has posted Tax Reform for REITs and Real Estate Businesses.

To understand the impacts on the real estate industry in particular, it is important to understand the big picture.  The new law lowered the highest marginal tax rates for individuals from 39.6% to 37% (some individuals will also need to pay unearned income Medicare tax as well). The highest marginal tax rate applicable to long-term capital gains stays at 20% for individuals. The other big change was a reduction in the corporate tax rate to 21%. Because qualified dividends are taxed at 20%, the effective tax rate on income from a C corp that is distributed to its shareholders will be 36.8% (plus Medicare tax, if applicable).

Benefits in the new law that particularly impact the real estate sector include:

  • REITs and other pass-through entities are eligible for as much as a 20% deduction for qualified business income;
  • favored treatment of interest expense deductions compared to other businesses;
  • Real estate owners can still engage in tax-favored 1031 exchanges while owners of other assets cannot; and
  • Some types of commercial real estate benefit from more favorable depreciation provisions.

While it is clear that real estate investors came out ahead with the new tax law, it is not yet clear the extent to which that is the case.

Republicans and the Mortgage Interest Deduction

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photo by Nick Youngson

There is a lot to hate in the Republican tax reform plan contained in the proposed Tax Cuts and Jobs Act. (click here for a summary and here for the text of the bill itself). Overall, the bill is extraordinarily regressive, heavily favoring the wealthy. There will, of course, be all sorts of compromises to this proposal as Republicans work to get it passed. But it is worth highlighting what is good about the bill as it would be a shame to lose sight of it while the sausage is being made in Congress.

The best real-estate related provision from a policy perspective is the reduction of the mortgage interest deduction. In a section of the summary with the Orwellian title, Preserving the Mortgage Interest Deduction, the Republicans outline how they will slice the deduction in half:

For so many Americans, buying a home is often the largest investment – and perhaps most important – investment they will make in their lifetime.

The Tax Cuts and Jobs Act will continue to support the American dream of homeownership by preserving the Mortgage Interest Deduction.

This ensures that hardworking families can continue to access this important tax relief as they buy, own, and maintain their home.

Policy Specifics

• Increasing the standard deduction means a simpler, fairer, and flatter tax code in which fewer taxpayers need to go through the trouble of determining whether they should itemize.

• Under the Tax Cuts and Jobs Act, taxpayers will still be able to deduct mortgage interest in excess of the standard deduction, in combination with other remaining itemized deductions, including charitable contributions and property taxes.

• The mortgage interest deduction would be available for interest paid on new mortgages for up to $500,000 in home acquisition indebtedness on principal residences.

• For existing mortgages, the plan allows for current law deduction on indebtedness of up to $1,000,000 and up to $100,000 in home equity to help taxpayers who may have relied on the current mortgage-interest deduction.

How This Policy Helps the American People

Preserving the home mortgage – and the deduction for state and local property taxes – will help more Americans of all income levels achieve the American dream of homeownership. (15-16)

This plan would cut the principal amount of a mortgage that would be eligible for the mortgage interest deduction from the current maximum of $1,000,000 to $500,000. Given that wealthy households generally take the mortgage interest deduction more often and get more bang for their buck from it, it is a regressive aspect of the tax code.

It is striking that a provision with such broad support such as the mortgage interest deduction is actually on the table. It will be interesting to see how special interests in the real estate industry will respond. My bet is that at the end of day the deduction will remain mostly untouched, even though this particular Republican proposal makes good policy sense.

Renters and Natural Disasters

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Bill Huntington

Avvo quoted me in What Do Renters Need To Know in A Natural Disaster? It opens,

From hurricanes in the East to wildfires in the West, the past few months have seen an on-going slew of natural disasters in the United States. Fires and floods don’t care whether a property is inhabited by owners or renters. However, most states have laws that  address how landlords and tenants deal with a rental property in the aftermath of a natural disaster.

Renters’ recourse in a natural disaster? Leases and local laws.

Check the lease first

The first source of authority on the obligations of landlords and tenants is found in the lease agreement, which should spell out the terms of what happens in case of a natural disaster. But not all leases clearly address this situation. According to Michael Simkin, managing partner of Simkin & Associates in Los Angeles, in cases where the lease is “burdensome or unfair,” local or state laws will govern what happens.

Landlord and tenant responsibilities vary by state

Every state has different laws regarding landlord and tenant obligations after a natural disaster strikes. Here are examples of answers to common tenant questions from some of the states recovering from recent natural disasters.

Can a lease be terminated if a natural disaster makes a rental property unusable?

California: If a rental property is destroyed in a natural disaster, the lease is automatically cancelled. The landlord must refund the rent for that rental period on a prorated basis.

“Many times, the city can come in and condemn the property and effectively force out tenants in unsafe situations. It is also the landlord’s responsibility to terminate a lease when they have knowledge that their rental property is unusable or unsafe,” notes Monrae English, a partner at Wild, Carter & Tipton in Fresno.

Florida: If the premises are “damaged or destroyed,” the tenant may terminate the rental agreement with written notice and move out immediately.

Louisiana: According to the Louisiana attorney general, if a natural disaster damages a property to the point that it is completely unusable, the lease is terminated automatically.

New York: If a rental becomes unfit for occupancy due to a natural disaster, the tenant may quit the premises and is no longer liable to pay rent. Any rent paid in advance should be returned on a prorated basis, according to David Reiss, law professor at Brooklyn Law School.

Texas: Either the tenant or the landlord can terminate the lease with written notice. Once the lease is canceled, tenants’ obligation to pay rent ceases and they’re entitled to a prorated refund of any rent paid during the time the home was not usable.

If the lease is terminated due to a natural disaster, does the renter get the security deposit back?

California: The landlord must return the security deposit within three weeks of the tenant vacating, with any deductions accounted for in writing. The landlord is not allowed to deduct disaster damage.

Louisiana: The landlord is required to return security deposits within one month, as long as the tenant fulfilled the lease obligations and left a forwarding address, according to Brent Cueria, an attorney with Cueria Law Firm, LLC in New Orleans. The landlord cannot deduct for natural disaster damage.

New York: The security deposit must be returned to the tenant, according to Reiss.

Texas: The security deposit must be refunded.

Foreclosure Body Count

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respres

Case Western’s Matt Rossman has posted Counting Casualties in Communities Hit Hardest by the Foreclosure Crisis (forthcoming in the Utah Law Review) to SSRN. The abstract reads,

Recent statistics suggest that the U.S. housing market has largely recovered from the Foreclosure Crisis. A closer look reveals that the country is composed not of one market, but of thousands of smaller, local housing markets that have experienced dramatically uneven levels of recovery. Repeated waves of home mortgage foreclosures inundated certain communities (the “Hardest Hit Communities”), causing their housing markets to break rather than bend and resulting in what amounts to a permanent transition to a lower value plateau. Homeowners in these predominantly low and middle income and/or minority communities who endured the Foreclosure Crisis lost significant equity in what is typically their principal asset. Public sector responses have largely ignored this collateral damage.

As the ten-year mark since the onset of the Foreclosure Crisis approaches, this Article argues that homeowners in the Hardest Hit Communities should be able to deduct the damage to their home values caused by the Crisis from their federal taxable income. This means overcoming the tax code’s usual normative assumption that a decline in a home’s value represents consumed wealth and, thus, is fully taxable. To do so, this Article likens the rapid, unusual and enduring plunge in home values experienced by homeowners in the Hardest Hit Communities to casualty losses – i.e. damages to personal property caused by a sudden force like a storm or a hurricane – which are deductible. The IRS and most courts have insisted this deduction is limited to physical damage. This Article carefully dissects the law and principles underlying the deduction to reveal that the physical damage requirement is overbroad and inequitable. When viewed in the larger context of other recent tax code interventions that allow those who have experienced personal financial harm due to a crisis to reduce their income tax base accordingly, home value damage in the Hardest Hit Communities actually fits comfortably within the concept of a casualty loss.

Notwithstanding its normative and equitable fit, the casualty loss deduction poses several administrative challenges in its application to the Foreclosure Crisis. This Article addresses each challenge in turn, explaining the extent to which the Treasury Department and the IRS, through administrative action and/or a careful application of case law precedent, can resolve it. The Article also identifies and grapples with the distributional reality that the casualty loss deduction, in its current form, provides a small or no return on lost home equity for a sizable number of low and middle income homeowners, which would make it a problematic method of recovery for homeowners in the Hardest Hit Communities. To make the deduction a better and more equitable fit under the circumstances, this Article identifies two, larger-scale modifications the federal government could adopt: (i) changing the method by which a casualty loss is valued for damage caused by the Foreclosure Crisis and/or (ii) lifting the floors and limits Congress has over time imposed on the deduction, as it has done for those taxpayers most heavily impacted by several recent hurricanes and droughts.

The article offers a creative response to ameliorate an aspect of the foreclosure crisis. Rossman concludes, “Once these homeowners are considered equally worthy of claiming a casualty loss, the question then shifts to how the IRS, the Treasury Department and/or Congress can best adapt and address the administrative and distributional challenges attendant to utilizing the casualty loss deduction in this context. These challenges are not insurmountable barriers, but rather issues to be carefully considered and strategically addressed.” (67)

I can certainly imagine some of those challenges, such as how to reliably identify a “permanent transition to a lower value plateau,” but articles of this type are just what we need as we try to figure out how to address housing crises of this magnitude.  While there was a big gap between the housing crises of the Great Depression and the Great Depression we can be sure that there will be another such event at some point in the 21st century.