Most experts agree that the 2017 Tax Cuts and Jobs Act will not, in and of itself, have a
significant effect on the national real estate market as a whole. Ralph McLaughlin, chief
economist at Trulia expects that “the fundamental financial benefits of buying a house compared
to renting one doesn't change enough to make renting a better option.” But, Trulia also found in
its 2017 survey, that Long Island, New York boasts the highest property tax rates in the country.
Long Island does not, however, reflect the homogenous, “coastal” lifestyle that some may
expect. So, it is difficult to anticipate how exactly the 2017 Tax Reform will affect our localized
markets; and yes, there are several.
Let’s consider the key components of the Tax Reform Act on which we, as industry
practitioners, should keep a close watch. In doing so, let’s assume that, if one is actually
surviving on Long Island, odds have it that Lower Tax Brackets, the Elimination of the
Personal Exemption, and Doubling of the Standard Deduction are relatively inconsequential
to any of Long Island’s real estate markets.
The Mortgage Interest Deduction: Today, homeowners can only deduct interest on
loans up to $750,000.00 for both first and second homes (combined) as opposed to the previous
$1,000,000.00 limit. The knee-jerk conclusion here would be that this may have a chilling effect
on Long Island’s luxury markets such as the Gold Coast, Hamptons, and North Fork, especially
for second-homes. But, remember those lower tax brackets? Maybe they aren’t so
inconsequential after all. Chances are that any mortgage interest deduction lost under the new
code will be offset by a 2.6% decrease in the tax rate for top earners (now $500,000.00 or more).
Additionally, many of these homeowners are also benefitting from the;
Lower Corporate Tax Rates: Corporate tax rates are slashed by 14% under the
new code, leaving corporations free to significantly reallocate earnings. One can only assume
that, in addition to the new employee bonus programs that have been widely publicized,
corporate executives (our top earners) are also slated to reap some of these rewards and now at
lower personal tax rates.
What may, however, have more of a direct effect on Long Island’s markets is the new
$10,000.00 Cap on State and Local Tax (SALT) Deductions. Previously, there was no limit on the amount of SALT deductions that property owners could claim on their federal returns.
While the same argument can be made for a potential offset with lower tax brackets and
corporate rates for our luxury market owners, the new SALT cap is sure to be a significant
concern to our mid-market homebuyers. After all, SALT rates above $10,000.00 are certainly
not limited to Long Island’s luxury markets as the above graph clearly shows.
This new cap on SALT deductions does not, however, apply to Rental Properties. Under the new code, bona-fide, income-producing properties enjoy a blanket 20% pass-through deduction before being subject to Federal Tax. Additionally, all rental expenses, including 100% of SALT payments may be itemized. As only 80% of net rental income may now be taxable, rentals are now much more profitable! This is surely to affect the machinations of the second home, seasonal, and commercial markets on Long Island. It is reasonable to expect an increase in corporate interest in these markets as well as a rethinking and restructuring by second home purchasers.
Similarly, the Tax Reform Act preserves the availability of 1031 Tax Deferred Exchanges for real property. While these tax deferred exchanges are no longer available for income-producing, personal property (i.e. aircraft, watercraft, etc.), individual and corporate landlords may still upgrade or downgrade their real estate holdings and benefit from a significant tax deferment… yet another perk for the rental and commercial markets.
But, what about the private homeowner and Capital Gains? Here, the Principal Residence Exclusion remains unchanged. After much debate and numerous proposals to either severely limit or entirely phase out the principal residence exclusion, the new code does preserve it for properties utilized as primary residences for at least two of the last five years.
So far we’ve summarized those components of the 2017 Tax Reform Act that are expected to have a direct effect, to some degree, on our real estate markets. Indeed, corporate and high net-worth property owners stand to reap most of its benefits. The lower and mid-level markets, however, will aspire to maintain the status quo after readjusting to the new tax “shell game.” The Taxman may taketh much of your SALT deduction, but giveth unto you a lower tax bracket. Now let’s look at the intangibles.
Alimony Payments are No Longer Tax Deductible for all divorce and separation agreements or decrees signed after December 31, 2018. If properly informed, the “monied spouse” is now sharply incentivized to settle all marital differences before year’s end! Could this incentive possibly help fill the demand for real estate inventory this year?
529 Savings Plans are no longer limited to higher education costs. A homeowner may now utilize up to $10,000.00 of 529 savings each year for elementary, private, or religious schooling. This incentive to donate to 529 plans may, yet again, serve to offset any loss of SALT or mortgage interest deductions in the luxury markets.
Finally, it is no secret that real estate investors, specifically “flippers,” have been hitting it out of the park in recent months on Long Island. The shortage of available inventory in most markets has translated to very short marketing and hold periods. Where project timelines are minimized, profits are maximized and there are no compelling disincentives for the successful investor to stay the course. A slight tack, however, may be considered. Could the Flip be Replaced by the Hold? In light of the 20% pass through income deduction for rental properties, more and more real estate investors may elect to hold and derive income rather than profit from their real estate ventures. Either way, the initial investment in Long Island real estate is incentivized.
The players have been chosen and the die cast. The Spring thaw is sure to reveal how and to what extent the 2017 Tax Reform will affect Long Island’s varied real estate markets. Likewise, the New York State of Mind will remain keenly focused on the I.R.S. in the coming months. It has yet to comment on the legality of Governor Cuomo’s charitable contribution work-around to the $10,000.00 SALT deduction limit.
By; Michael A. Ferruggia, Esq.
Ferruggia & Calisto, LLP (Founding Partner)
New York Center of Real Estate (Founder & President)
Hamptons & North Fork REALTORS® Association (Board Counsel)
Michael Ferruggia is a founding partner of the law firm of Ferruggia & Calisto, LLP now with offices in Central Islip, Southampton, Miller Place, and Melville, New York. His private practice concentration is in real estate transactions and litigation, representing an extensive base of institutional, corporate, and private clientele. Mr. Ferruggia is consistently engaged as an educational speaker for numerous not-for-profit agencies and as a keynote lecturer and industry trainer for all aspects of real property law, policy, transactions, and market dynamics in both the private and public sectors. He has served as an Adjunct Professor of Law at both the Patchogue and Bethpage, New York campuses of Briarcliffe College and as an expert witness in Real Estate for the Grievance Committee of the New York State Bar Association.
Committed to raising the industry standard of practice in New York, Mr. Ferruggia founded The New York Center of Real Estate (NYCORE) in 2013; a fully accredited real estate school offering relevant and contemporary Continuing Education programs to New York State REALTORS®.
Mr. Ferruggia is also currently serving as Counsel to the Board of the Hamptons North Fork REALTORS® Association (HANFRA). As such, he is entrusted to act as legal liaison and the voice of Long Island REALTORS® in state and national matters.