How the new tax law affects homeowners — it could be more than you think
The Tax Cuts and Jobs Act (TCJA) trimmed two important tax breaks for homeowners and left another big one completely untouched. That sounds pretty simple, but it’s a fairly complicated story when you consider real-world situations. So I’ll present the story in two bite-sized installments. Here’s Part 1.
New limit on deductions for state and local taxes, including real property taxes
Under prior law (before the TCJA), you could claim an itemized deduction for an unlimited amount of personal (non-business) state and local income and property taxes on Schedule A of Form 1040. So if you had a big property tax bill, you could deduct the whole thing if you itemized. Individuals with big personal state and local income tax bills could fully deduct those too on Schedule A, if they itemized. Finally, you had the option of deducting personal state and local general sales taxes on Schedule A instead of state and local income taxes (beneficial if you owe little or nothing for state and local income taxes).
For 2018-2025, the TCJA changes the deal by limiting itemized deductions for personal state and local property taxes and personal state and local income taxes (or sales taxes if you choose that option) to a combined total of only $10,000 ($5,000 if you use married filing separate status). Personal foreign real property taxes can no longer be deducted at all, so no more deductions for property taxes on that place in Cabo.
These TCJA changes unfavorably affect individuals who pay high property taxes because they live in a high-property-tax jurisdiction, own an expensive home (resulting in a hefty property tax bill), or own both a primary residence and one or more vacation homes (resulting in a bigger property tax bill due to owning several properties). Individuals in these categories can now deduct a maximum $10,000 of personal state and local property taxes — even if they deduct nothing for personal state and local income taxes or general sales taxes.
Tax planning considerations
First of all, none of the preceding factors matter unless you have enough 2018 itemized deductions to exceed your allowable standard deduction. That will be the case for fewer folks than under prior law, because the TCJA almost doubled the standard deductions for 2018 compared to 2017. Specifically, the 2018 standard deduction for married joint-filing couples is $24,000 (compared to $12,700 for 2017). The 2018 standard deduction for heads of households is $18,000 (versus $9,350 for 2017). The 2018 standard deduction for singles and those who use married filing separate status is $12,000 (versus $6,350 for 2017).
Second, there is not much opportunity for gamesmanship with deductions for real property taxes. The only way you could potentially deduct more than $10,000 (or $5,000 if you use married filing separate status) is if you own a home that is used partially for business (for example, because you have a deductible office in the home) or partially rented out (for example the basement of your main residence or a vacation home during part of the year). In those situations, you could deduct property taxes allocable to those business or rental uses on top of the $10,000 limit — subject to the rules that apply to deductions allocable to those uses. (For example, home office deductions cannot exceed the income from the related business activity, and deductions for the rental use of a property that is also used as a personal residence generally cannot exceed the rental income.)
If you pay both state and local property taxes and state and local income taxes (or sales taxes if you choose that option), trying to maximize your property tax deduction may reduce what you can deduct for state and local income taxes. For example, if you have $8,000 of state and local property taxes and $10,000 of state and local income taxes, you can deduct the full $8,000 of property taxes but only $2,000 of income taxes. If you want to deduct more income tax, your property tax deduction goes down dollar-for-dollar.
Warning: If you are in the alternative minimum tax (AMT) mode, itemized deductions for personal state and local property taxes are completely disallowed under the AMT rules. Ditto for itemized deductions for personal state and local income taxes (or sales taxes if you choose that option). This AMT disallowance rule was in effect before the TCJA, and it still applies in the post-TCJA world.
The good news: home sale gain exclusion rules unchanged
The TCJA preserves the valuable break that allows you to potentially exclude from federal income tax up to $250,000 of gain from a qualified home sale, or $500,000 if you are a married joint-filer. The proposed House and Senate bills both included restrictions on this big tax-saver, but the final bill did not change the existing rules. Good!
The bottom line
The new TCJA limits on deducting property taxes will affect many homeowners. The new limits on deducting home mortgage interest may not affect as many, but homeowners with larger mortgages and home equity loans must take heed. I’ll cover the new rules for home mortgage interest in my next column. So please stay tuned.