How The New Law Will Affect First-Time Homebuyers

By HOM Editor

Woman

This example is drawn from The Tax Cuts and Jobs Act – What it Means for Homeowners and Real Estate Professionals, an in-depth review by the National Association of REALTORS® (NAR).

To illustrate how the changes to the standard deduction, repeal of personal exemptions, mortgage interest and state and local taxes might affect a first-time homebuyer, consider the example of Barbara Buyer. Barbara, an accountant making $58,000 per year, is single and currently rents an apartment. She also pays state income tax of $2,900 and makes charitable contributions of $2,088, but the total of these is lower than the standard deduction, so she claims the standard.

Barbara’s tax liability for 2018 under the prior law is as follows:

Salary income $58,000
Standard deduction ($ 6,500)
Personal exemption ($ 4,150)
Taxable income $47,350
Tax $ 7,491

Under the new law, Barbara would get a tax cut, computed as follows:

Salary income $58,000
Standard deduction ($12,000)
Personal exemption ($ – 0 -)
Taxable income $46,000
Tax $ 6,060

Tax Difference Under New Law. Even though Barbara would not get the benefit of the personal exemption under the new law, her higher standard deduction would more than make up for the loss. In addition, the lower tax rates of the new law would help deliver the total tax cut of $1,431 ($7,491 – $6,060) as compared with the prior law.

However, let’s take a look at what happens to Barbara if she were to purchase the condo that she likes costing $205,000. She takes out a 30-year fixed rate mortgage at 4% interest, putting down 3.5%. Assuming she buys early in 2018, her first-year mortgage interest would total $7,856 and she would pay real property taxes of $2,050.

As a first-time homeowner, her tax liability under the prior law would be computed as follows:

Salary income $58,000
Mortgage interest $ 7,856
Real property tax (1%) $ 2,050
State income tax (5%) $ 2,900
Charitable contributions (3.6% of income) $ 2,088
Total itemized deductions ($14,894)
Personal exemption ($ 4,150)
Taxable income $38,956
Tax $ 5,393

Note. Under the prior law, Barbara would lower her tax liability for 2018 by $2,098 ($7,491 – $5,393) by purchasing the condo. This is the financial effect of the prior law’s tax benefits of buying a home. This amount effectively lowers her monthly mortgage payment by $175 per month.

Now, let’s take a look at what her tax situation would be under the new law as a first-time homebuyer:

Salary income $58,000
Mortgage interest $ 7,856
Real property tax (1%) $ 2,050
State income tax (5%) $ 2,900
Charitable contributions (3.6% of income) $ 2,088
Total itemized deductions ($14,894)
Personal exemption ($ – 0 -)
Taxable income $43,106
Tax $ 5,423

Tax Difference Under New Law. Even though Barbara would still be able to claim all of her itemized deductions under the new law, she would lose the benefit of her personal exemption. This would mean that her taxes would actually go up under the new law by $30 ($5,393 – $5,423). But far worse, look at the tax differential between renting and owning a home. This difference, which was $2,098 under the prior law, has now shrunk to just $637 ($6,060 – $5,423), or $53 per month. In other words, under the prior law, Barbara was given a strong incentive to move into the ranks of those who own their home. The new law still offers her an incentive, but it is a shadow of what it was, and is unlikely to be very compelling.


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