Four Important Tax Changes that All Real Estate Investors Need to Know
In late December of 2017, after rounds of negotiations and votes in the U.S. Senate and House, President Trump signed into law the Tax Cuts and Jobs Act, the most significant overhaul of the national tax code in over 30 years.
This new tax code has already had an impact on all sectors of the economy, include real estate investors. It has impacted investor confidence, changed incentives, and made new incentives for pass-through entities. It’s also capped deductions on mortgage interest, as well as state and local taxes.
These effects are important to the overall picture of the real estate market, and while other factors, such as rising interest rates, may tamper the positive effects of tax reform, it’s likely that the new tax code will help make real estate a desirable place to invest for the foreseeable future.
This article is for general information only and should not be considered financial or tax advice. San Diego Purchase Loans is a CPA or tax firm in any way, and you must always speak with a qualified expert in national, state, and local tax code before making any decisions related to real estate investment strategies.
How the New Tax Code May Impact Real Estate Investors
Impacting Investor Confidence
Once it was passed, the tax reform law removed a lot of the uncertainty that was starting to build. In 2017, investors weren’t sure what to expect, so merely passing the law created confidence, stability, and relative predictability. Because many of the provisions will be in place for eight to ten years, investors are able to move forward with specific plans.
One of the most dramatic changes was the adjustment in the corporate tax code, which dropped from 35% to 21%. This has provided an opportunity to increase corporate profits, and businesses will likely spend this increase in additional facilities, which could further bolster spending in commercial real estate. It could also boost wages, which generally leads to higher consumer spending.
Changing Tax Incentives for Real Estate Investors
The tax reform law also brought changes in the bonus depreciation rules. By taking advantage of these changes, real estate investors are able to deduct a portion of their costs if certain assets are being used for the business.
The changes to this area include a first-year bonus depreciation for qualifying assets that are acquired and placed into service between September 2017 and December 2022. This is increased from 50% to 100%.
After this period, the IRS will gradually phase out first-year bonus depreciation over a five year span. Also, starting in 2018, bonus appreciation will include the purchase of used property in addition to new.
If you have rental properties, you will now be able to deduct the costs of personal property in residential units, and the definition of qualifying property is expanded to include specific nonresidential improvements, such as roof repairs, fire protection, and the installation of alarm systems.
The deduction limitation is also increased to $1 million, up from $510,000 in 2017, while the phase-out threshold is increased from $2.03 million to $2.5 million.
Creating Incentives for Pass-Through Entities
Another incentive that has been created is for pass-through entities, which are essentially a business that allows you to claim income on your personal tax returns instead of a separate business tax return. This includes LLCs, Series LLCs, and S Corporations.
The new adjustments allow investors to benefit from an income tax deduction of up to 20% of qualified business income. The deduction may be available to real estate investors, regardless of whether they personally own the property or own it through a business entity.
To take advantage of this benefit, the investor can deduct either 20% of qualified business income or 20% of the investor’s taxable income minus their capital gains. For an investor that has taxable income over $157,500 ($315,000 for joint filing) the “greater of” test will be applied. (Talk with a tax professional for information on this system.) The 20% deduction cannot exceed 50% of the W2 wages paid by the business or 25% of the W2 wages paid by the business plus 2.5% of the unadjusted income tax basis.
If you are earning income with a pass-through entity, you should consider how to structure your entity to maximize this available incentive. Real estate investors are also encouraged to allocate their business expenses, including interest, so they don’t miss on certain deductions. This will allow them to fully maximize the 20% pass-through benefit.
Capping Deductions Related to Real Estate
One of the most hotly-debated features of the 2018 tax reform bill was the adjustments in deductions for mortgage interest and state and local taxes. These changes may have a negative impact on some people, but it’s believed that they will produce a positive effect on the residential real estate market. If you invest in vacation home properties, you’ll want to give this topic particular extra attention.
The mortgage interest deductions on new mortgages for both primary and secondary homes is now limited to $750,000; it was $1 million before the tax reform. Taxpayers who took out mortgages before December 15th 2017, however, can continue to claim up to $1 million, or $500,000 if married and filing separately. Business properties do not have limitations on mortgage interest deductions, which is a benefit to companies and employers.
If you are an investor, you will no longer be able to deduct interest on a home equity loan unless the loan is used to acquire or improve a qualifying residence. This is subject to the same limits that we described above.
At the higher end of the market, these changes could make homeownership less appealing, which could in turn cause a cooling in overall market activity.
Providing Superior Loans No Matter What the Tax Code
While San Diego Purchase Loans is not an accounting or tax firm, we can help you get the best possible mortgage for your specific situation.
No matter what the current tax code, getting a mortgage loan with ideal interest and terms remains essential, and with our common-sense approach to lending, we can help you get the right loan for investments, primary homes, vacation properties, and more!