With federal tax reform on Congress’ agenda after its August recess, two ideas that have been circulating have the potential to hit Chicago-area homeowners, one of them much harder than the other.
Two federal tax deductions—one for mortgage interest and the other for state and local taxes—are in the cross hairs of reformers. The interest deduction would likely be revised, not eliminated, because it’s a hallowed perk of homeownership, most reports say.
But the loss of the state and local tax deduction would cut deeper in the Chicago region anyway, analysts in the real estate, mortgage and tax realms say.
Eliminating the state and local tax deduction could transfer almost $2.9 billion a year out of Illinois household wealth and into federal coffers, according to Brian Bernardoni, senior director of government affairs and public policy for the Chicago Association of Realtors. That is, unless that larger tax reform package includes adjustments to the general federal income tax rate that offset this amount.
Here’s why the deduction is a broader issue in Chicago than mortgage interest. First, 280,000 more Illinois homeowners used it on their 2014 taxes. According to Bernardoni’s research, more than 1.77 million Illinois taxpayers deducted real estate taxes, compared to 1.49 million who took the mortgage interest deduction.
On top of that, the mortgage interest deduction “is most valuable when you first buy your house and loses its value over time,” Bernardoni said. Because the early years of payments on a mortgage are mostly interest and little principal, the possible deduction is far larger then than in later years, as the interest portion of the payment diminishes and the principal part grows.
The state and local deduction, though, “gets more valuable over the years, as your home’s value appreciates and the taxes on it go up,” Bernardoni said. “That’s the one that will hurt more homeowners, including people who’ve already paid off the house but still get a property tax bill.”
With property taxes in Illinois among the highest in the nation, “removing that deduction would have a disproportionate effect on Illinois taxpayers” who own their homes, said Carol Portman, president of the Taxpayers Federation of Illinois.
Illinois taxpayers who itemized in 2014 deducted about $11.5 billion in real estate taxes, according to Bernardoni, saving nearly $2.9 billion in taxes they would have paid the federal government.
Eliminating the state and local deduction, which has been in place since 1913, would capture $96 billion in federal revenue in 2017 alone and $1.3 trillion over the course of a decade, according to the Tax Policy Center, based in Washington, D.C. Most media discussion of Congressional Republicans’ tax reform plans indicates the lost deductions would be offset with more taxpayer-friendly tax rates, though nothing is guaranteed.
Shifting $1.3 trillion out of homeowners’ household wealth “would have a chilling effect on refinancing and possibly prevent people from going out and buying a bigger home,” said Nathan Britsch, a board member at the Illinois Mortgage Bankers Association and vice president of compliance at Chicago-based Perl Mortgage. “When people suddenly don’t have the assets they previously had because they lost that tax deduction, I can see that making them not want to (go deeper into real estate debt).”
While part of contemporary life entails swallowing ever-increasing taxes, Portman said, the loss of the state and local deduction might be harder to stomach.
“People don’t think much about taxes when they’re buying something small,” she said, but when buying a home or doing their tax returns, “they’re crunching bigger numbers, and they’re keenly aware of the benefit to the cost of homeownership” that deductions provide.
Nobody’s forecasting a downturn in the local housing market because of a lost tax deduction. But Britsch said a lost state and local deduction would “add to so many headwinds that are already in the market” here, including slow price growth and fast-rising property taxes in the city.
In a rising, prosperous real estate market, the loss of the tax deductions might not bite as hard, but “if someone is not able to pull equity out of their home, the deduction can prove to be very advantageous.”
Without it, “you would have less incentive to own a home, and renting might be more attractive.”