The passage of the Tax Cuts and Jobs Act into law brings major changes to the local real estate market that prompt anxious anticipation about the shifting role and rewards of homeownership. Depending on the resulting effects the law has on home evaluations, it could cause the Falls Church City Council to adjust previous promises in order to keep recently approved major public projects on schedule for completion.
Here are the basics of the law’s alterations to the real estate market: It reduces the limit of the mortgage interest deduction (MID) from $1 million to $750,000 for all loans taken out after Dec. 15, 2017, applies a cap to itemized state and local tax (SALT) deductions at $10,000 while doubling the standard deduction for all filing status categories.
The law also preserves the capital gains exclusion that allows single taxpayers to exclude up to $250,000 (and $500,000 for married couples) from a home sale as long as they’ve lived in the home for two of the past five years. The capital gains exclusion was a necessary victory for realtors in the transient Washington, D.C. area (and more relevantly, in the City of Falls Church) since it makes home sales much more palatable for owners who may be required to move due to work obligations.
Essentially, the law is expected to cool the hot housing market by trimming the amount of tax incentives associated with purchasing a home and slow the natural appreciation of home values in the process. It makes the absolute value of buying a home cheaper, but also decreases the financial support given by the government.
Increases to the standard deduction makes the tax differential between 90 percent of renters and homeowners nominal, according to the National Association of Realtors. Add in the lowered MID and the cap on SALT deductions and owning one of the high-priced homes that are standard to the D.C. metro area rather than renting a modest flat becomes less savory. But even with all the changes, realtors don’t believe it will have a pronounced effect on local sales despite some decline in home values.
“If homes are priced correctly, they will sell,” Lorraine Arora, Chairman of the Northern Virginia Association of Realtors (NVAR) and managing broker at Weichert Realtors in Fairfax, said. “[Homes sold] during the savings and loan crisis and when interest rates were at 18 percent. It will be a bit of a challenge, but buyers have to see what’s right for them because it’s so specialized. We may see a dip [in sales], but we’ve seen that before.”
Arora’s sentiment is agreed with by Re/Max West End agent Louise Molton, who works in the City. Molton acknowledges that certain parts of the new law, such as stripping away personal exemptions, even out the clear benefits of the law’s other aspects such as the doubled standard deduction. But in general, most people will be paying less overall in taxes and therefore will have more money to spend on items such as housing – as long as the price is right.
However, Molton felt the MID reduction could have an indirect effect on sellers. Without government subsidies being as generous toward prospective buyers, many may decide to pursue houses outside of the City that fall comfortably within their price range. If buyers become fickle, sellers may consider hovering around the $750K threshold in order to make a stronger case in the market.
Or, they could become dissatisfied that their investment isn’t appreciating at the expected rate and hold out until the market becomes ripe again, according to Nicholas Lagos, an NVAR board member and associate broker at Century 21 in Arlington. Since the buyers of larger homes are typically the sellers of smaller homes, Lagos believes the law runs the risk of bogging down the natural turnover in ownership that facilitates the dispersion of wealth in society.
Reducing the MID was a curious move due to the deduction’s legacy in modern American lore. Both political parties have touted homeownership as the surest path to middle class stability and the bedrock of the American Dream. The MID has been pitched as the vehicle to help people achieve that dream.
Now tax benefits between a large majority of renters and homeowners will be negligible. Though the equity advantage of owning a home versus renting will still remain, it begs the question of why exactly homeownership is being de-emphasized as the building block toward financial security.
“The jury’s still out on that one,” Lagos said. “One of the biggest benefits of purchasing a home is to have that deductibility. In a sense, this almost discourages homeownership.”
As the dust settles, it will become easier to forecast the law’s concrete effects on the local real estate market. City Assessor Ryan Davis estimates it could take until early 2019, at the latest early 2020, to identify any detectable trend in shifting home valuations, though Treasurer Jody Acosta believes a viable projection could be possible by the fourth quarter of this fiscal year.
While the market takes shape, the City government prepares itself for the perceivable obstacles the law presents toward the completion of the Capital Improvement Projects (CIP). Property taxes account for roughly 60 percent of the City’s total revenue. If home values take a hit due to the new law, then so does the City’s wallet during a historically ambitious period of public works with the renovations of City Hall, Mary Riley Styles Library and the construction of a new George Mason High School all on tap for the next six years.
As the News-Press reported back in September, City Manager Wyatt Shields alerted the City Council that a projected six-cent increase to the real estate tax will be required for the first four years before being reduced to a four cent increase in order to front load the borrowing to fund the CIP. The City has diversified its revenue stream with growing commercial development, but property taxes still provide the lion’s share of Falls Church’s revenue. If home values sink to an uncomfortable level, the City may be inclined to raise the tax rate even more to ensure the projects stay on schedule.
“As long as there’s that political will to raise the tax rate to what it should be, then no, there shouldn’t be [delays to the CIP],” Acosta said. “But I don’t know if there’s that political will out there to adjust the tax rate if needed.”
Per Acosta, the City likes the idea of modifying the tax rate to equalize any shift in assessments that occur due to market or legislative circumstances. But since she joined the City government in 2006, she’s only seen the tax rate adjusted once because of changes in assessments — when they ballooned in the period leading up to the Great Recession. Otherwise, she expects them to keep rates the same due to already high expenses the City is saddled with.
Falls Church’s ability to absorb financial shocks shouldn’t be discounted. It endured and recovered from the Great Recession and some unfavorable court rulings on its ability to draw a return on investment from its water system. And it did so at an accelerated rate due to the upper-middle class demographic that flocks to the City for its schools and homey feel.
Residents are so well-heeled that the flood of property taxes paid to beat the enacting of the Tax Cuts and Jobs Act in recent weeks were largely done out of pocket, rather than through an escrowed account with a mortgage lender. That prevalence of wealth could signal that reductions to the MID and SALT may not be as detrimental to home sales in the City as some fear.
However, it’s still in a “wait and see” mode. Molton speculated that lowered SALT deductions on top of CIP tax hikes could dissuade prospective buyers from living in Falls Church. If housing inventory grows, it would put a downward pressure on the assessments and put the City government in the aforementioned bind regarding what to do about tax rates. Though with no solid answers on how the market will react to the new law until at least the early summer, no new solutions can be broached about how to move forward.