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International Property

US government tax plan no worry for property buyers in upscale Hamptons area

The government is considering taking away mortgage-interest deductions for second homes, but buyers are preparing by turning their holiday homes into investment property

PUBLISHED : Monday, 13 November, 2017, 8:00pm
UPDATED : Tuesday, 14 November, 2017, 7:07pm

Out in the Hamptons, the US beach resort on Long Island favoured by Wall Street’s denizens, brokers and buyers already have a workaround for a tax-plan provision under consideration in Congress that would take away mortgage-interest deductions for second homes.

A client of Brown Harris Stevens broker Jessica von Hagn who works at a hedge fund decided to turn the holiday home he is buying into an investment property by setting up a limited liability company. That will allow him to deduct the interest and earn rental income at the height of the season from the modern home, which has four bedrooms, three bathrooms and a swimming pool and an acre of land and is located in the village of Bridgehampton.

For the buyer, that is a problem solved, while for the Hamptons market it means more high-end holiday properties will be listed as rentals, and so more competition and, most likely, falling rents.

“If you aren’t able to take advantage of the mortgage deduction for your second home, you’ll see more people putting their homes on the market and the inventory will grow,” von Hagn said.

“There’s only a certain number of renters every season and we just keep adding more and more inventory.”

In second-home markets across the US, from Cape Cod in Massachusetts to Lake Tahoe, California, brokers are bracing for a hit. A House version of the tax plan, passed by the Ways and Means Committee on Thursday, cuts the mortgage-interest deduction on second homes and on home-equity loans, which buyers sometimes take out on their primary residence to pay for a holiday property. The Senate’s plan, details of which were released late on Thursday, also does away with the home-equity deduction, but preserves the break for second-home mortgages.

Should the final bill eliminate the tax deduction for holiday properties, the workaround – acquiring the home as an investment property – changes the nature of the purchase for buyers, turning their holiday home into a business. Second-home buyers typically purchase properties within 200 miles of their primary residence, and 72 per cent of them finance the purchase, according to the National Association of Realtors.

“It’s a shift from favouring owners to favouring landlords,” said Danielle Hale, chief economist for Realtor.com. “It adds rental inventory and reduces the time people spend at second homes potentially.”

If markets were flooded with properties for lease, rents would fall and so would the values of those homes, she said.

The main focus of the tax debate on real estate has so far centred on mortgage-interest deductions for primary residences. The Senate version of the plan would preserve the existing write-off for up to US$1 million of debt, while the House would reduce it for new purchases to US$500,000 of debt.

Even before any change is passed by Congress, the possibility that the second-home mortgage deduction will be gone is already changing the calculus for some buyers, said Timothy Bailey, a broker with John C. Ricotta & Associates in the affluent Cape Cod town of Chatham.

Bailey said an agent told him that one of her deals, for a US$1.5 million holiday property, fell apart over the tax plan.

“My whole living relies on selling second homes,” Bailey said. “Because it’s a discretionary purchase, if they lose that deduction, it might be more attractive to rent.”

The biggest impact will be felt at the lower end, for homes costing less than US$2 million, according to brokers. At higher price points, buyers may pay cash or opt to take advantage of other tax benefits, such as buying the homes as investment properties, writing off upkeep and interest, and using them part of the year for themselves.

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In the Midwestern city of Aspen, Colorado, as much as 70 per cent of second homes are bought with cash, so the interest deduction is irrelevant, said Tim Estin, a broker with Aspen Snowmass Sotheby’s International Realty.

“Our market relies on the winds of the ultra-rich, who will be getting a reputed tax break anyway that should more than make up for the loss of the mortgage deduction,” said Estin, who writes the Estin Report on the Aspen market.

“For the rich, a mortgage is more a source of cheap funds – bankers line up to loan them real estate money in the hopes of relationship-building – and the deduction aspect is almost ancillary.”

That raises a fundamental question for Anthony Sanders, an economics professor at George Mason University in Fairfax, Virginia.

“Is that really something we should be subsidising – holiday homes?” Sanders said. “If people can afford to buy a holiday home, they can afford not to have a deduction.”

But the lives of many middle-class Americans are made better because they have affordable holiday retreats, said Lawrence Yun, chief economist for the National Association of Realtors.

“Clearly, even though it’s discretionary spending, it’s not only on the upper end,” Yun said. For example, “there are many cabins in Michigan, and these are for middle-class families to go hunting or fishing.”

Yun said the plan also would have an economic impact on affordable second-home markets such as Murphy, a town in North Carolina’s Great Smoky Mountains, where local businesses depend on part-time residents.

Whatever happens with the tax plan, the Bridgehampton buyer isn’t worried. He is paying more than US$2 million for his 3,400 sq ft holiday home, and though he will end up spending less time there than he had originally hoped, he figures the rent he will earn will more than cover his property taxes and help pay the mortgage.

And he will still be able to enjoy the two-storey charcoal-coloured house, the landscaped garden and heated, granite pool with inlaid spa and waterfall – for at least part of the season.

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