Did the $10,000 cap on deductibility of state and local taxes on property introduced through the Tax and Jobs Cut Act of 2017 lead to a decline in home sales in 2018? New research from the Federal Reserve Bank of New York [1] (New York Fed) points to a high possibility of this rule impacting home sales.
The analysis which was published on New York Fed's Liberty Street Economics [2] blog noted that while mortgage rates had risen by almost 70 basis points between the fourth quarter of 2017 and the third quarter of 2018, sales of new homes had declined by 7.6% and those for existing homes had dipped 4.6% during the same period.
However, the researchers, Richard Peach, SVP, in the New York Fed's Research and Statistics Group and Casey McQuillan Senior Research Analyst in the New York Fed's Research and Statistics Group noted that these declines in home sales were larger than in the two previous episodes when mortgage interest rates rose by a comparable amount.
Also, the largest decline in home sales, according to the research was seen in home sales in the higher price range, where the $10,000 cap was most likely to have made an impact.
The New York Fed said that while its analysis provided circumstantial evidence that specific provisions such as "a $10,000 cap on the deductibility of state and local taxes, a lower limit on the amount of mortgage debt on which interest is deductible, and lower marginal tax rates have negatively impacted the housing market," it remained to be seen exactly how much of the recent home sales decline was due to "higher interest rates versus changes in tax law."
Comparing the rise in interest rates in 2017-2018 with two previous such bumps (Q1 2013 to Q4 2013 and Q2 2016 to Q1 2017) the researchers revealed that between Q2 2016 and Q1 2017, home sales had actually risen 10%. They also noted that during these periods, unlike what was seen in 2017-2018, whenever sales did fall "the declines were concentrated in the lower price ranges while the sales in higher price ranges continued to increase."
The research concluded that with the economy booming in 2018, it was expected that the housing market would most likely "shrug off" the rise in interest rates as seen during the previous two periods. However, "this most recent episode is qualitatively different because of changes in the tax code," which when combined with the rise in interest rates increased the marginal user cost of capital for homeowners, "especially for higher-priced homes and homes in high-tax jurisdictions."
Read the complete analysis here [3].