Photo of a young mixed-race family admiring a home - possibly their first home, or the home they hope to own.

Evolution in the Tax Code: (Almost) the End of Homeowner Tax Savings?

Incentivizing homeownership has been a bedrock public policy in the U.S. since the Great Depression. One way the federal government promotes homeownership is by including favorable provisions in the income tax code that reduce income tax liabilities for homeowners versus similar income taxpayers who rent.

Relevant provisions in the tax code include the nontaxation of implicit rental income, in essence the taxable income owners would generate if they leased the home to another household, the exclusion of capital gains on housing used as a principal residence, the ability to deduct state and local taxes (SALT) of which property taxes on housing are a large component, and the ability to deduct mortgage interest.

Economists have long recognized and debated the efficacy and efficiency of these provisions. However, the passage of the Tax Cuts and Jobs Act (TCJA) of 2017 renewed interest in how the tax code favors housing with one of its key provisions being a $10,000 limit on the deductibility of state and local taxes (SALT). 

Brent Ambrose, Pat Hendershott, David Ling and Gary McGill.

From left: Brent Ambrose, Pat Hendershott, David Ling and Gary McGill.

Recently, members of Congress from places with high state-and-local taxes have renewed attacks on this provision and have introduced legislation to restore full SALT deductibility arguing that the SALT limitation disproportionally impacts middle-income households in their districts. Their argument is that the SALT limitation is unfair by substantially raising the taxes on middle-income households.

Is this true? An informed debate regarding the implication of the SALT deduction limitation requires a clear understanding of how the tax code treats owner-occupied housing relative to renters across income levels and geographic locations. This is especially important when the discussion centers on equity and fairness.

In a recently completed research paper, we provide insights into this question by using data from the American Housing Survey and the NBER TAXSIM software to estimate the federal income tax liability and tax benefits associated with homeownership for a representative set of taxpayers across the United States. 

Our analysis shows that differences across states in federal income taxes paid arise from variation in the ability to fully deduct state and local income, sales, and real property taxes (i.e., “SALT” taxes). As a result, the SALT deduction limitation increased taxes for many households – but only for those who itemize, which shrunk from 33% of taxpayers in 2017 to 11% in 2018. As a result, it is widely recognized that the SALT deduction limitation most adversely affects upper income households (or those most likely to itemize deductions rather than take the standard deduction) in markets with higher house prices and/or high rates of state taxation.

Our analysis shows that removing the SALT limitation would result in substantially lower federal income taxes for high-income households. For example, a representative high-income NJ household (earning between $400,000 and $1,100,000) would see federal income taxes cut by $14,401 (or 15.7% of 2018 income taxes paid) following restoration of the full SALT deduction.

Our analysis reveals that many states without generally high house prices or with low state taxes also contain concentrations of affected taxpayers. For example, even in relatively a low-cost midwestern state, such as Ohio, removing the SALT deduction limitation would reduce federal income taxes by $5,466 (or 5.2% of 2018 taxes paid) for households earning between $400,000 and $1,100,000. Thus, as has been reported in numerous media posts, restoring the full SALT deduction will primarily benefit only high-income households.

But, most importantly for the arguments for a progressive tax code, our analysis reveals that restoring the full SALT deduction will have a minimal impact on the income taxes of middle-income households. For example, in the high-cost coastal states of CA, NJ, and NY, the limitation on SALT deductions has only modest impact for the representative middle-income household earning between $100,000 and $150,000. Removing the SALT deduction limitation for these households would reduce federal income taxes by $16 (or 0.1% of 2018 taxes paid) for CA residents, $149 (or 1.2% of 2018 taxes paid) for NY residents, and $407 (or 3.1% of 2018 taxes paid) for “middle-income” NJ residents. Across all states, the median tax savings from restoring the full SALT deduction for these middle-income households is $0. 

Unfortunately, focusing on only the SALT deduction limitation ignores the substantial benefits that homeowners receive relative to similarly situated renters. If one is to consider fairness and equity, then a full accounting of the income tax codes provisions for homeowners is necessary.

Toward that goal, we calculated the largest tax benefits of owner-occupied housing: the nontaxation of the implicit rental income and the nontaxation of capital gain income earned on invested housing equity. This allows us to measure the “net tax savings” of homeownership, calculated as the taxes a household would pay if it rented its residence minus the taxes it pays as an owner. Our analysis reveals several important findings. First, although the TCJA reduced the benefits of homeownership for many (itemizing) households (by limiting the SALT deduction), these lost tax savings are very often small relative to the tax benefit associated with the nontaxation of the return on equity invested in the home. Most homeowners still receive a significant tax benefit from owning, rather than renting, their residence.

Furthermore, our analysis reveals the extent that households in high house price markets benefit relative to similar income households in lower priced housing markets by the non-taxation of implicit rental income. For example, the typical middle-income homeowner in CA, NJ, or NY (earning between $100,000 and $150,000) enjoyed federal income tax savings of $2,763 (or 22.5% of 2018 taxes paid), $1,930 (or 14.6% of 2018 taxes paid), and $1,792 (or 13.8% of 2018 taxes paid), respectively. The average homeownership tax savings benefit across all states for homeowners with incomes between $100,000 and $150,000 was $1,099 (or 8.9% of 2018 taxes paid).

To illustrate the disparity in the distribution of housing tax benefits, consider that midwestern states of Ohio, Iowa, Missouri, and Indiana, the representative homeowner with income between $100,000 and $150,000 only received $501, $262, $256, and $233 in homeownership tax savings benefits, respectively, or between 8% to 18% of the homeownership tax benefit enjoyed by similar income households in California.

Thus, our analysis points out an often-overlooked disparity embedded in the tax code and suggests that calls to reinstate the full SALT deductibility and the grounds of equity and fairness are disingenuous. It is disingenuous for politicians from high-cost coastal states such as NY, NJ and CA to claim that the SALT limitation is unfair to “middle income” residents of their states when the vast majority of the benefits from removing the SALT limitation would accrue to the highest income homeowners; thus removing the SALT limitation would essentially be a large tax cut for high-income homeowners. Finally, our analysis points out that homeowners in NY, NJ and CA already receive tax benefits well above the level received by the average US homeowner.

Brent Ambrose is the Jason and Julie Borrelli Faculty Chair in Real Estate and Director of the Institute for Real Estate Studies at the Pennsylvania State University.

Pat Hendershott is Professor Emeritus at the University of Aberdeen and The Ohio State University.

David Ling is Ken and Linda McGurn Professor and Director of the Nathan S. Collier Master of Science in Real Estate at the University of Florida Warrington College of Business.

Gary McGill is Associate Dean of the University of Florida Warrington College of Business, Director of the Fisher School of Accounting and J. Roy Duggan Professor.