Hot off the Press: Real Estate Loopholes and Limitations in the New Tax Bill
After much debate and several rounds of changes, the U.S. Congress has passed one of the most comprehensive tax changes in recent history. Within the tax reform, many deductions will be taken away, but many new tax loopholes and benefits will be available for the first time.
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For real estate investors, there are things that you can do today to take advantage of the upcoming tax change and save taxes in the long run. Although the majority of the tax changes will take place in 2018, there are a few changes that actually impact the 2017 year. With the details of the tax changes finally revealed, we now have a better idea on what action items to consider to position ourselves for lower taxes for 2017 and beyond.
Here are the highlights of some of the more important parts of the tax change that may be impactful to real estate investors:
16 Highlights of the New Tax Bill
1. After much debate, the primary home gain sale exclusion did not change.
It remains at $250k/$500k for single/married couples and is eligible for properties that are lived in as a primary home for at least 2 out of the last 5 years.
2. Home equity line of credits (HELOC) for primary homes are no longer tax deductible starting in 2018.
However, if the HELOC proceeds are used to acquire or improve an investment property, the related HELOC interest remains tax deductible, so make sure that you are tracking your interest expenses accurately. HELOC proceeds taken out on investment properties continue to be tax deductible provided proceeds are used for investment properties and not personal expenses.
3. Interest deduction is limited to the first $750k of debt taken out after 12/15/17 on primary and second homes.
Similar to above, if the primary home loan proceeds are used for investment properties, the entire interest expense may be tax deductible against rental income and escape the new limitation. Mortgage interest, however, for investment properties continues to be tax deductible without the $750k limitation.
4. Business entertainment expenses are no longer tax deductible starting in 2018.
Therefore, consider prepaying for entertainment expenses by 2017 year-end if appropriate.
5. In the past, certain business-related meals were 100% tax deductible.
Starting in 2018, all business meals will be limited to 50%.
6. If you are an investor purchasing business assets (equipment, furniture, fixtures, appliances, computer, etc.) for your real estate activities, there is now a 100% bonus depreciation deduction available if the asset is purchased after 9/27/17.
This results in an immediate write-off of the expense versus the need to depreciate it over time. For the first time, the bonus depreciation applies to both new and used items. Bonus depreciation can be applied to vehicles used in a real estate business although subject to certain limitations.
7. Section 179 now allows for certain taxpayers to take an immediate deduction of up to $1M on assets placed in service for a business.
In the past, this excluded real estate activities, but starting in 2018, this is now available to non-residential real estate and appears to be available for lodging businesses such as a dormitory and Airbnb. Examples of eligible assets may include roofs, heating, HVAC, fire protection, and security systems.
8. The new tax bill limits the deduction of certain business interest expense to 30% of taxable business income.
Luckily, most real estate businesses are exempt from this limitation.
9. Although 1031X is repealed for most business assets, it remains intact for real property.
As such, 1031X is still a solid strategy for investors looking to sell our rentals and defer taxes down the road.
10. If you do decide to sell a property outright, capital gains rates remain in effect under the new law.
Therefore, holding properties for over one year can qualify for a lower tax rate as in previous years.
Related: If My Income Phases Me Out of Real Estate Tax Benefits, Should I Stunt My Growth Plans?
11. Although it was in the original proposals to accelerate depreciation of commercial and rental properties, the final bill did not give us this tax benefit.
Depreciation for residential and commercial properties remains at 27.5 years and 39 years, respectively.
12. Tax preparation fees are no longer deductible in 2018 as an itemized deduction.
However, the fees are still deductible against rental income so make sure to allocate a reasonable percentage of your tax preparation fees to Schedule E to lock in that tax benefit.
13. The amount that is free from estate taxes has doubled to $11M for single people and $22M for married people.
Taxpayers also continue to receive step-up basis upon death. As such, for many investors who are under the exemption amount, it may still be a good strategy to wait to transfer appreciated investment properties to beneficiaries upon death to obtain tax-free gain during the investor’s lifetime.
14. With the C Corporation’s new lower tax rate of 21%, certain active real estate business may pay lower taxes by operating in this entity structure.
Although corporation tax rates are lowered, the downside of double-taxation still remains in effect, so make sure to discuss any entity modifications thoroughly with your tax advisor before making any changes to your entity structure. For the many investors who own rental properties, C Corporations are still not recommended to hold title to these rentals from a tax perspective.
15. The new tax reform provides certain flow-through business income with a 20% deduction, which essentially makes 20% of the profit to be tax-free.
This benefit is available for income earned through LLCs, S Corporations, Partnerships, Sole Proprietorships, and Schedule E rentals. Certain service based businesses will not qualify if the taxpayer’s taxable income is above $207k/$415k. For non-service based businesses with income above 157k/315k, additional limitations need to be factored in if taxable income is above this threshold. This deduction does not apply to interest, dividends, and capital gains income.
16. Prior to the passage of the tax bill, investors involved in flipping were generally eligible for a Domestic Production Activity Deduction (DPAD) on their earnings.
This deduction has been repealed in the new law.
Although not every deduction listed is favorable, the new tax law allows for a lot more flexibility and tax planning opportunities for real estate investors. The good news is that since most of the changes start in 2018, there are plenty of time for planning opportunities. Make sure to keep in touch with your tax advisor to plan accordingly for 2018 and beyond to keep more of your hard-earned money.
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