How GOP Tax Plan Could Hobble Housing Market

House Republicans on Thursday unveiled a tax bill that would reduce or eliminate virtually all of the tax incentives of homeownership, promising to reshape an industry that accounts for nearly one-sixth of the U.S. economy and drives the biggest financial transaction most Americans make in their lifetimes.

The proposed legislation would cut in half the size of loans that qualify for deductions of mortgage interest, to $500,000 from $1 million. At the same time, it would nearly double the standard tax deduction, to $24,400 for married couples in 2018, ensuring that only a tiny sliver of homeowners, primarily in the priciest housing markets, will continue to itemize their returns to capture the break.

The bill also appears to eliminates the mortgage interest deduction for second homes and further limits, for top earners, a break on capital gains from real estate sales.

"It's one step removed from the worst-case scenario, and that's a small step," said Isaac Boltansky, director of policy research at Compass Point Research & Trading, a Washington, D.C.-based investment bank. "It is basically the sum of all [the industry's] realistic fears."

Shares of home builders and residential real-estate brokerages tumbled after the bill was unveiled. The S&P Homebuilders ETF ended the day down 2.5%, while shares of luxury builder Toll Brothers Inc. fell about 6% and shares of Realogy Holdings Corp., a residential brokerage, shed about 7%.

Mortgage lenders worried the bill could hurt their business and weren't clear on how the loan refinancing market might be affected. Housing-industry groups such as the National Association of Realtors and National Association of Home Builders came out in opposition to the bill.

"The corporations are getting a major tax cut, and it's getting paid for by the equity in American homes," said Jerry Howard, chief executive of the NAHB.

The legislation "threatens home values and takes money straight from the pockets of homeowners," said NAR President William E. Brown, a California Realtor. "Tax hikes and falling home prices are a one-two punch that homeowners simply can't afford."

One silver lining for the housing industry: the bill would retain a deduction for property taxes, albeit with an annual cap of $10,000, which is a blow to homeowners in high-tax states like New York and New Jersey. In all, roughly 3.7 million U.S. households paid more than $10,000 a year in property taxes in 2016, including 30.5% of owner-occupied homes in New Jersey, according to an analysis of census data by the NAHB.

Even without the $500,000 cap, the mortgage interest deduction already was hobbled by a plan to increase the standard deduction. The Tax Policy Center, a nonpartisan group headed by a former Obama administration tax official, previously estimated that the blueprint released earlier this fall could reduce the share of taxpayers who claim the deduction to 4% from 21% currently.

Nationally just 2.8% of mortgage loans have a balance greater than $500,000, according to CoreLogic Inc. Of the 7.7 million single-family-home mortgages made last year, 548,000 -- or 7% -- were over $500,000, according to the trade publication Inside Mortgage Finance.

Economists said the changes come at a sensitive time for the housing industry.

Single-family home prices rose on an annual basis in 92% of 177 U.S. metropolitan areas in the third quarter, according to a Thursday report from the NAR. That was the largest share of metros notching price gains in more than two years.

But the gains were driven by a shortage of homes for sale. At the end of the third quarter, there were 1.9 million homes on the market, 6.4% fewer than the same period last year. The average supply during the second quarter was 4.2 months, down from 4.6 months a year earlier. Economists say six months is typical of a balanced market.

"We have affordability issues as it is. If you make it more difficult for people to put money toward the house, or take away the economic benefits of them owning a house, it really, really could be a major problem," said Rick Sharga, executive vice president of Ten-X, an online marketplace for real estate.

Mr. Howard of the NAHB said the tax overhaul could cause a housing recession because of a potential drop in home values. States with high housing costs, including California, where more than a third of homes are valued above $500,000, would be particularly hard hit, he said.

"Republicans have always claimed that they don't want to pick winners and losers in the economy," he said. "They are clearly picking large corporations over small businesses, and they are clearly picking wealthy Americans over the middle class."

To be sure, the $500,000 cap on the mortgage interest deduction would apply only to loans made after Nov. 2, which protects existing homeowners. But experts said that is likely to exacerbate the current stagnation in the housing market.

Homeowners in high-cost cities like New York, Boston, Los Angeles, San Francisco and parts of Florida are less likely to trade up to larger, more expensive homes if they know that means losing the protection on the mortgage interest deduction, which in turn makes it difficult for younger buyers to enter the market.

"In those expensive markets that already have an inventory crunch it's probably going to make the situation worse," said Ralph McLaughlin, chief economist at Trulia. He said this is likely to drive up prices.

Mortgage lenders, meanwhile, worried the tax bill could weaken their businesses by taking away some of the incentives of homeownership.

The bill also could have an impact on the refinancing market. Lenders said it appeared that the lower, $500,000 deduction would also apply when existing mortgages were refinanced, which could discourage borrowers from refinancing even if they have a relatively high interest rate.

Some lenders said the bill also appeared to curb the tax benefits of cash-out refinances by eliminating the deductibility of the portion of the mortgage that exceeds the value of the debt being rolled over.

Critics said that could hurt the economy because borrowers often tap equity to pay for their children's college or to renovate their homes, which boosts consumer spending.

For high-income households, the bill phases out a rule in existing tax law that excludes the first $250,000 in profits from a home sale, or $500,000 for a married couple, from capital-gains taxes. The change would affect home sellers with incomes exceeding $250,000 for individuals or $500,000 for married couples.

The NAR and NAHB were split in their early strategy on tax reform. The Realtors remained behind the mortgage interest deduction, while the builders for the first time in 30 years said they were open to changes.

That may have weakened their negotiating position earlier in the process, experts said. "The unfortunate industry split that led to the push for a mortgage tax credit, I think left the entirety of the mortgage [interest deduction] out on a limb," Mr. Boltansky said.

Now both groups are united in opposition to the bill. "There's going to be a ferocious fight ahead and the housing industry is going to be a central player in that fight," he said.

--Richard Rubin contributed to this article.

(END) Dow Jones Newswires

November 02, 2017 18:26 ET (22:26 GMT)