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Tax reform bill has major implications to MID for most homeowners

Under a new tax reform bill known as the Tax Cuts and Jobs Act out of the House of Representatives, a cap on mortgage-interest deductions or MID could have a significant effect on new homebuyers, particularly those looking for a home in affluent coastal markets.

Through the MID, taxpayers can reduce the interest paid from loans amounting to up to $1 million, whether accumulated over a single home or through multiple properties. The bill proposes lowering the limit to $500,000, as well as possibly eliminating the MID for second homes, according to this article from the Wall Street Journal.

Changes will only affect mortgages that were signed after November 2, which means existing mortgage interest will still fall under previous rules and will continue to be deducted. This change will likely affect first-time home buyers.

Under current rules, roughly a third of all homeowners get financial benefits from the MID through itemizing their taxes. Those who benefit pay a significant amount of mortgage interest, and usually have relatively large mortgage balances. The current administration and the Congress propose tax changes that will double the standard deduction and will prohibit the deduction of local and state taxes.  

With the new rules, today’s average home buyer with a 20% down payment will need to purchase a home that is priced at least $805,000, compared to just $305,000 under previous laws, according to Zillow. By this estimate, this greatly reduces the number of homeowners who will benefit from the MID by about 30% of the population to a mere 5%.

How this may affect California

Should these proposals pass, the state of California will not experience devastating effects, compared to the rest of the country. Since home values are already currently high throughout the state, taking the MID in California is almost always beneficial to the buyer. However, the proposed rules will still reduce the percentage of California homeowners taking the MID, from 96% to 30% in Los Angeles, 99% to 59% in San Francisco, and 94% to 20% in San Diego, to cite a few examples.

The controversy generated by the MID largely comes from the fact that it favors the wealthiest Americans by a large margin. It presents huge benefits to affluent US citizens with large mortgages at the expense of low to middle class homeowners with smaller mortgage balances.

Rise in standard deduction

Months before the bill was releases, the Tax Policy Center estimated that an increase in the standard deduction will potentially result in a drop in the amount of itemizers from about 45 million to 18 million. Due to the bill’s impact on existing tax incentives for home buyers, several home building organizations have opposed the bill, including the National Association of Realtors as well as the National Association of Home Builders.

For those thinking about buying a home while still itemizing deductions despite the increase in standard deductions, the new cap on the MID won’t likely have an effect.