Season 1 : Episode 1 – Tax implications affecting the Real Estate
- No longer UNLIMITED mortgage interest deductions?
The new tax bill has reduced mortgage interest deductions to a total of $750,000 of mortgage debt for first or second homes. And while this may seem favorable for new home buyers within the $750,000 limit, anyone looking to buy property from expensive markets is bound to experience a tax disincentive.
To fully avail of mortgage interest deductions, try not to buy a property over the $ 750, 000 price limit. Note that if you get it at a price close to the limit, when you eventually sell the property and value has risen to the limit or above it, it might be more difficult to sell. Refer to # 5 for exceptions.
- Not all HELOCs are created equal.
Beginning in 2018, the deduction for interest paid on a home equity line of credit (“HELOC”) will no longer be eligible for the home mortgage interest deduction.
Planning to get a home equity loan? Well, you will have to spend your home equity loan on home improvement in order to qualify for interest deductions. You can also use the equity loan to acquire a second home and you can still deduct the interests.
- Easy on the SALT!
State and local taxes (referred to collectively as “SALT”) can be deducted but will no longer be unlimited as under current tax law. The 2018 tax law will allow homeowners to deduct property taxes and either income or sales taxes with a combined limit on these deductions being limited to no more than $10,000.
For homeowners residing in high-tax states like New York, California and New Jersey, or anyone with a heavy property tax burden, the $10,000 limit might not cover all of your SALT.
- To itemize or opt for standard deduction – that is the question!
For 2019, the standard deduction for taxpayers doubles under the new law, to $12,200 for individuals and $24,400 for joint filers.
Since standard deduction has increased, some taxpayers who used to itemize may now opt to use the standard deduction. The implication being, it may remove the tax incentive of moving from renting a home to home ownership .
- Truly a 100% bonus!
Qualifying property acquired and placed in service after Sept. 27, 2017 is eligible for 100 percent bonus depreciation in the year it is placed in service. The 100 percent rate drops by 20 percent per year beginning in 2023, until it is eliminated in 2027. Also, now for the first time, the 100 percent expensing is available for both new and used property. Eligible assets are those with a depreciable life of 20 years or less and are expected to include the expanded definition of “qualified improvement property.” Qualified improvement property under the TCJA comprises work done to the interior of a commercial building and placed in service any time after the date the building was first placed in service. It does not include costs related to the enlargement of the building, an elevator or escalator, or the internal framework of the building. However, a real property trade or business (RPTB) has the option to elect out of the business interest limitation, thereby allowing it to deduct its interest expenses in full. An RPTB includes development, construction, rental, management, leasing and brokerage activities. The trade-off for this election is that the RPTB must depreciate its assets, including qualified improvement property, using ADS rules, which means bonus depreciation is not available.
Whew, that’s a long one. Here goes in KISS terms, moving forward if you are expecting huge net income before taxes, it may be wise to acquire a rental property and charge all the qualified improvements on the property 100% to the bonus depreciation to increase your expenses and decrease your net income.
Remember the $750,000 mortgage interest deduction limit? Well, if the property is under your rental, development, or construction company, you can opt to elect out of this interest limitation. Bad news is that you can’t have your cake and eat it too…if you elect out of the interest limitation, you cannot avail of the 100% bonus depreciation. Real property will have to be depreciated under longer recovery periods of 40 years for a nonresidential property, 30 years for a residential rental property, and 20 years for qualified interior improvements. So, compute and choose wisely!
- Seriously, 20% deduction from business income?
TCJA permits a deduction of up to 20 percent of the qualified business income from pass-through entities (partnerships, LLCs, and S Corporations) and sole proprietorships – individuals who own their real estate directly or through a single member LLC. The deduction is available to both individual owners and trusts, and is computed at the individual or trust level. It is limited to the lesser of (a) 20 percent of qualified business income, or (b) the amount that is the greater of (i) 50 percent of W-2 wages paid by the qualified business or (ii) 25 percent of W-2 wages paid plus 2.5 percent of the unadjusted basis of qualified depreciable property used in the qualified business.
Qualified depreciable property includes property that has a depreciable period that ends at the later of 10 years from the date the property is placed in service, or the end of its regular depreciable tax life. Property that has a MACRS depreciation period shorter than 10 years is treated (solely for this purpose) as being depreciable over 10 years.
Gain from the sale of real estate, except for depreciation recapture, is not considered qualified business income, and is therefore ineligible for the 20 percent deduction. REIT dividends are treated as qualified business income, whereas interest, dividends, and capital gains are not.
Simply said, business owners can now deduct 20% (pass through income ) from their business profits and will only get taxed on the remaining 80%! There are limitations on W-2 wages earned by the business owner though. The effect of this is, they will be taxed 29.6% on income that would otherwise be taxed at 37%. Hey, even REIT dividends are qualified as business income.
Since our aim is to KISS ( Keep it Simple, Stupid!), our interpretation might be too simplistic for those with long and complicated issues regarding a particular topic. We suggest that you avail of our free consultation at UNI Accounting Services or approach your own CPA, lawyer, estate planner or financial coach to expound further on a topic which may catch your attention.
Irene Uy is a senior manager of UNI Accounting services primarily responsible for USA based clients.