Jerry Baker, a Westside auto mechanic, is befuddled by all the recent talk about federal tax reform.
"I don't own an apartment building, I don't own a vacation home, and I don't have shares in a real estate partnership," he says. "The only real estate I own is my home, and I have absolutely no idea how tax reform is going to affect me and my house."
Baker, 36, is not alone. While volumes have been written about how the legislation recently passed by the Senate and House Joint Conference Committee would affect most other forms of real estate investments, analysts have spent little time contemplating tax reform's effects on homeowners like Baker.
Overall, experts say, homeowners who don't have other real estate investments will emerge from the Tax Reform Act of 1986 relatively unscathed. The nation's most cherished write-off--deductions for mortgage-interest payments--has been spared. So have several other popular housing-related tax breaks.
Curbs on Refinancing
But the bill may also carry some nasty, expensive surprises for some homeowners who have already refinanced their homes or were planning to tap their equity for retirement purposes. It would also put limited curbs on future refinancings, and could limit a home's appreciation potential.
"From what we understand, tax reform should be a major stimulus for the residential, single-family housing market," said Lou Piatt, senior vice president of the Beverly Hills-based realty brokerage firm of Jon Douglas & Co. "The single-family home will be the most attractive sheltering opportunity a family can have."
A key factor in Piatt's optimism is that families still will be allowed to deduct the interest they pay on their home loans, even though deductions for non-mortgage interest payments will gradually be phased out. Families fortunate enough to own a second home or vacation property will get to write off interest payments on that property, as well.
In addition, Piatt notes, property-tax payments will also remain fully deductible.
On the Downside
The measure also would continue to allow people who sell their home to defer taxes on any profit as long as their new home is worth at least as much as their old one. And people 55 or older who sell their homes without reinvesting their cash will still be allowed to avoid taxes on the first $125,000 of their profit.
On the downside, housing-related deductions will be worth less because most people will be in a lower tax bracket. Under current law, for example, a taxpayer in the 50% tax bracket gets a 50-cent deduction for each dollar paid in interest charges. Under the new law, that dollar would provide the homeowner with no more than a 33-cent deduction--and possibly less.
Tax-writers also put restrictions on the interest deductions consumers can take when they refinance their home. The new code would limit mortgage-interest deductions to the original purchase price of the home, plus the cost of improvements the owner has made since then. The only homeowners exempt from this limitation are those who use the refinancing proceeds to pay for home improvements or educational or medical expenses.
Example of Guidelines
The National Assn. of Home Builders offers this example to show how the new refinancing guidelines work:
A family bought a house in 1978 for $50,000 and has since made $10,000 in improvements. The home's current market value is $120,000, and the owner wants to refinance it for $100,000. The new law would only allow the family to deduct interest payments on $60,000 of the loan (the original purchase price and the $10,000 in improvements). Interest payments on the other $40,000 wouldn't be deductible unless that money was used to pay for additional home improvements, educational expenses or medical bills.
This new rule might not seem important, but it could cost many homeowners who have already refinanced their homes thousands of dollars. That's because the current wording of the refinancing change makes the measure retroactive .
This would particularly hurt longtime owners who have recently refinanced to "tap the equity" they have in their home; these taxpayers may find their interest deductions sharply reduced in coming years.
'It Could Hurt People'
"We'll have to see the final wording of the bill and the transition rules before we really know what effect reform will have on homeowners," said Joe Knott, managing partner in the Los Angeles tax office of real estate consultant Kenneth Leventhal & Co. "Clearly, if the limits (on refinancing) are retroactive, it could hurt people who have already refinanced large amounts."
Realtor Richard Rosenthal of Venice, president of the California Assn. of Realtors, said the restrictions could prompt some current property owners to sell their home and buy another house.