State and Local Tax (SALT) Deduction

The State and Local Tax (SALT) deduction is a feature of the U.S. federal tax code that allows taxpayers who take an itemized deduction to subtract certain taxes they've paid to state and local governments from their federally taxable income. Think of it as the federal government giving you a bit of a break for the taxes you're already paying closer to home. Before 2018, this deduction was unlimited, providing a significant benefit to residents of high-tax states. However, the game changed dramatically with the passage of the Tax Cuts and Jobs Act of 2017 (TCJA), which introduced a cap on how much you can deduct. This cap has reshaped the financial landscape for many households and has had ripple effects on real estate markets and even interstate migration—all factors a savvy investor should keep an eye on. The deduction primarily covers property taxes plus a choice between either state income taxes or state sales taxes.

At its core, the SALT deduction lets you reduce your taxable income at the federal level by the amount you paid in certain state and local taxes. But you can't just add up every local fee you paid. The IRS has specific rules about what counts. For most people, it boils down to two main categories.

You have to make a choice. You can deduct either:

• Your state and local income taxes, OR
• Your state and local sales taxes.

You can't have your cake and eat it too—it's one or the other.

• For most people in states with an income tax (like California or New York), deducting income taxes is usually the better deal, as the total is typically higher than what they paid in sales tax.
• For residents of states with no income tax (like Florida, Texas, or Washington), the choice is simple: they deduct their sales taxes. The IRS provides tables to help estimate this amount, or you can keep all your receipts if you're feeling particularly meticulous (and made large purchases like a car or boat).

In addition to your choice of income or sales tax, you can also deduct your state and local real estate taxes. This is the tax you pay on the value of property you own, most commonly your primary residence. It can also include taxes on other properties you own, like a vacation home. This portion is a major component of the SALT deduction for homeowners.

The SALT deduction used to be a much bigger deal. Before 2018, it was unlimited. A homeowner in a high-tax suburb of New Jersey might have paid $25,000 in property taxes and $15,000 in state income taxes, allowing them to deduct a whopping $40,000 from their federal income. Then came the TCJA. The new law put a firm ceiling on the party, capping the total SALT deduction at $10,000 per household per year ($5,000 for a married person filing separately). This means that whether you pay $12,000 or $120,000 in state and local taxes, the maximum you can subtract from your federal income is $10,000. This was one of the most controversial parts of the tax reform, as it directly increased the federal tax burden on many residents in high-tax, typically “blue” states.

A tax deduction might seem like a topic for your accountant, not your investment portfolio. But the SALT cap is a powerful economic force with tangible consequences for investors.

The math is simple: a smaller deduction means a bigger federal tax bill. For affluent households in states like New York, California, and Illinois, the SALT cap can translate to thousands of dollars in extra taxes each year. This directly reduces their disposable income—the money left over after taxes to save, invest, or spend. A value investor analyzing a company that sells luxury cars or high-end vacations should consider that a portion of its target market now has less cash to splash around.

When the cost of living in one place goes up, people start looking for alternatives. The SALT cap effectively raised the after-tax cost of homeownership in high-tax states. This has fueled a well-documented migration trend of individuals and even companies moving from high-tax states to low- or no-tax states.

• Winners: States like Florida, Texas, and Tennessee have seen an influx of new residents and businesses, boosting their economies.
• Losers: States like New York and California are grappling with the loss of high-earning taxpayers.

For an investor, these demographic shifts are pure gold. They can signal opportunities in regional banks, local construction companies, and real estate investment trusts (REITs) that are positioned to benefit from growth in the “Sun Belt” and other low-tax regions.

The SALT cap has an interesting side-effect: it makes municipal bonds (munis) even more attractive. Munis are debt securities issued by state and local governments, and the interest they pay is typically exempt from federal income tax. For an investor in a high-tax state who just lost a huge chunk of their SALT deduction, the tax-free income from a muni issued by their own state (which is often exempt from state and local tax, too) becomes a much more compelling alternative to taxable investments. The cap makes this “triple tax-free” feature shine even brighter.