by Keith Powers
On January 1, 2018, the Tax Cuts and Jobs Act went into effect. This tax reform bill, the most sweeping rewrite of the tax code in more than thirty years, will have a major impact on divorcing homeowners.
While I certainly do not proclaim to be a tax professional, nor is this tax advice, here’s what you need to know from a real estate perspective.
Earlier proposals of the tax reform bill would have had a significant effect on divorcing homeowners, but fortunately, capital gains did not change. There is still a $250,000 (single) and $500,000 (married) deduction for homeowners who have lived in the property for at least two out of the last five years and whose property value has appreciated. Kathy Orton, How the tax bill impacts homeowners, buyers and sellers, The Wash. Post (Dec. 20, 2017), https://www.washingtonpost.com/news/where-we-live/wp/2017/12/20/how-the-tax-bill-impacts-homeowners-buyers-and-sellers/?noredirect=on&utm_term=.16d11a6029bc.
For example, if Bob and Mary Smith bought their primary residence in 2014 for $400,000 and they sell it now for $675,000, the $275,000 increase from 2014 and 2017 is what “capital gain” refers to. Since they lived there for two out of the last five years, the $500,000 married Capital Gains exemption may apply.
The prior proposals moved to increase the live-in requirement to five out of the last eight years, which would have been devastating to homeowners since we have seen massive price appreciation in the last five years.
Property Tax Deduction
This is the amount we, as homeowners, pay for our property tax. We used to be able to fully deduct our property tax, but as DS News reports, “Instead, the legislation allows individuals to deduct up to $10,000 in state and local income and property taxes or state and local property and sales taxes. That means homeowners living in high-tax states like New York, California, and New Jersey could see an increase in what they owe.” David Wharton, President Trump Signs Tax Bill Into Law, DS News (Dec. 22, 2017), https://dsnews.com/daily-dose/12-22-2017/president-trump-signs-tax-bill-law.
Mortgage Interest Deduction
Before the new law went into place, homeowners could deduct the mortgage interest accrued on the first $1,000,000 of mortgage debt. That amount has been reduced to $750,000. Paul Katzeff, Six Big Rule Changes for Individuals in the New Tax Bill, Inv. Bus. Daily (March 23, 2018), https://www.investors.com/etfs-and-funds/ personal-finance/5-big-rulechanges-for-individuals-in-the-new-tax-bill/. Previous proposals attempted to reduce that number to $500,000, so $750k is better than it could have been!
Taxation Changes for Spousal Support
Under the current income tax rules, the person paying spousal support can claim the support payment as a deduction on their taxes, and the person receiving spousal support must claim the support as taxable income. For divorces finalized in 2019 and thereafter, this will no longer be the case. Once the new rules take effect, the person paying spousal support will no longer be allowed to deduct the spousal support payment and the spouse receiving support will not have to claim the support as income. Bill Bischoff, New tax law eliminates alimony deductions— but not for everybody, MarketWatch (Jan. 26, 2018, 2:52 PM), https://www.marketwatch.com/story/new-tax-law-eliminates-alimony-deductions-but-not-for-everybody-2018-01-23. From a tax perspective, this is a win for the spouse receiving spousal support. For the spouse paying spousal support, not so much. When it comes to alimony, the paying spouse is generally the higher earner and, therefore, taxed at a higher rate. The receiving spouse is typically the lower earner and taxed at a lower tax rate. So, when it comes to alimony dollars, under the current rule, there are fewer tax dollars to pay, resulting in more dollars available. Under the new rule, where there are more taxes to pay, the result is less money to get the case settled. For most divorcing couples, alimony has always been both an incentive to the payor and a useful settlement tool to avoid trial. The new tax rule will undoubtedly impact that incentive. Right now, the window is still open, and if your divorce is filed and finalized before January 1, 2019, the current tax rules still apply. Id. After that, the new rule will inevitably reduce the amount of cash available to settle a case using spousal support.
Impact on Home Affordability
The new income tax changes will negatively affect spousal support payors, affecting their ability to qualify for buyouts and new home purchases. This is due to the underwriting guidelines that allow for an income tax deducting spousal support from income tax, rather than applying it as a liability. This may throw off debt-to-income ratios, making some payors ineligible to qualify for a new loan. Conversely, the new law will positively affect the spousal support recipient, because spousal support income will be non-taxable and can be increased for income-qualifying purposes.
The Bottom Line
Everyone’s situation is different, and what applies to another individual may not be true for you or your clients. Always check with a tax professional for advice on how the new tax laws could affect you, your family, your business, and your cases. The IRS website contains more details on the new bill at: irs.gov/newsroom/tax-reform.
Keith Powers is the owner of Powers Realty Group. He is a Certified Divorce Real Estate Expert (CDRE) who specializes in the sale of real property in adversarial Family Law cases. He can be reached at BrokerPowers@gmail.com.