THE Thread on the Final GOP Tax Bill - Q&A

Tax, SDIRAs & Cost Segregation
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THE Thread on the Final GOP Tax Bill - Q&A

Brandon Hall
CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes

Happy Holidays! As of today, the House and Senate have sent the GOP Tax Plan to the President to sign into law. 

I've seen numerous threads popping up about the GOP Tax Bill. I wanted to start a thread to consolidate questions and basically provide a user guide (via the Q&A) for years to come. 

I invite all tax pros on BP to contribute to this thread. It will be neat to see discussion on the tax bill itself, but also loopholes and strategies that develop once the massive bill has been digested. 

Link to the bill.

Key highlights from the bill: 

1. Mortgage interest deduction allowed on up to $750k of new acquisition debt starting Jan. 1, 2018. (Does not apply to rentals)

2. Interest paid on home equity loans that are not "acquisition debt" is not deductible. (Debt tracing rules will apply - if you use a HELOC to buy rentals, you can still deduct the interest).

3. State and Local Taxes (SALT) are limited to an aggregate $10,000.

4. A "freebie" deduction will be available beginning in 2018 for "combined qualified business income." Calculating the deduction can be complicated. Per our current understanding, you cannot use the deduction for activities generating passive losses. This includes sole props, meaning you do not need to utilize an entity (LLC/S-Corp) to qualify for the deduction as far as we can tell.

5. C-Corp tax rate reduced to 21%. 

6. AMT still exists but the exclusion is higher.

7. Bonus depreciation is now 100% for assets with a useful life of less than 20 years.

8. 529 plan funds can now be used to pay for public, private, and religious elementary and secondary education.

9. Penalty from Obamacare individual mandate has been eliminated.

10. Rehabilitation tax credit reduced in scope.

11. Domestic Production Activity Credit (DPAD) eliminated. 

12. Standard deduction increased, personal exemptions eliminated. 

What did not change:

1. Section 121 Exclusion - aka Capital Gain Exclusion on primary residence

2. Depreciation schedules. (Except for commercial properties on ADS). 

Ask away!

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Brie SchmidtBusiness Member
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Real Estate Broker · Chicago, IL · Member since 2013 · 6k+ posts · 5k+ votes
8y

I am so glad for BP and people smarter than me!

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  • Joe SplitrockPro Member
    Moderator
    Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
    8y
    Originally posted by @Brandon Hall:

    @Joe Splitrock allocating more value to land would really only work for new acquisitions, not current properties. 

    I understand. My point was that if I change my method of allocating on new properties, it will be inconsistent with existing properties. Wouldn't it be strange if every property I purchased up until 2018 had 15% allocated for land and all the sudden it changes to 40% on new acquisitions? I am not sure my CPA would agree to that.

    1Reply
  • Austin M.
    Real Estate Professional · Royal Oak, MI · Member since 2012 · 32 posts · 15 votes
    8y
    I am sure you will have to base it on comparable sales (vacant land sales prices). That is what is done now to calculate the land value.

    Originally posted by @Joe Splitrock:
    Originally posted by @Brandon Hall:

    @Joe Splitrock allocating more value to land would really only work for new acquisitions, not current properties. 

    I understand. My point was that if I change my method of allocating on new properties, it will be inconsistent with existing properties. Wouldn't it be strange if every property I purchased up until 2018 had 15% allocated for land and all the sudden it changes to 40% on new acquisitions? I am not sure my CPA would agree to that.

    0Reply
  • Brandon Hall
    OP
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    8y

    @Joe Splitrock I don't think so. There are several ways to determine basis. (1) look up the allocation between building and land in the property assessor database; (2) look at the underwriting on your insurance policy; (3) look at the appraisal if you had one; (4) find local land listings and apply the price/sqft to your lot.

    You can use any of those methods. 

    What you can't do is arbitrarily choose a random number of 15% and say that's the land value. THAT is what will get you in trouble. If there's no evidence to support the calculation, you'll have a hard time defending yourself from any inquiry.

    So when I say allocate more basis to land, what I really mean is, among those four primary methods I mentioned above used to determine basis, choose the method that produces the highest land value. 

    4Reply
  • John Woodrich
    Flipper/Rehabber · Minneapolis, MN · Member since 2016 · 1k+ posts · 1k+ votes
    8y
    Originally posted by @Brandon Hall:

    Strategy #2

    If you have the option of being paid on a 1099 basis (as a contractor) rather than a W-2 (employee), and if you make less than $157,500 if single or $315,000 if married, then you need to take a really hard look at making the switch to 1099 pay.

    Doing so will allow you to qualify for the 20% freebie deduction.

    Example: You make $100,000 as a W2 employee. You have no other income, and you're not married. You take the standard devolution of $12,000 so your net taxable income is $88,000.

    On the flip side, you make $100,000 as a contractor. You take the standard deduction of $12,000 AND $20,000 (20% of $100,000). Your net taxable income is $68,000. 

    The tax savings will be roughly $4,500. 

    Obviously this is a very high level example meant for illustrative purposes only. 

    Unfortunately getting a W-2 and a 1099 are not a matter of choice. Employment law will dictate which one you should be. 

    SE taxes and the ability to deduct expenses will also throw off this calc.  Typically people are paid more as independent contractors because of tax, benefits, etc.

    2Reply
  • Dong Yan
    Real Estate Investor · Irvine, CA · Member since 2016 · 129 posts · 42 votes
    8y

    Does that mean we should pay the 2nd installment tax this year to gain little tax benefits?

    0Reply
  • Brandon Hall
    OP
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    8y

    @John Woodrich of course, everything you said is important. That's why I said that was just a high level illustrative example. 

    But if you're not looking at 1099 vs W2 starting in 2018, you could be leaving money on the table. 

    2Reply
  • Jocelyn Canfield
    Easton, PA · Member since 2013 · 42 posts · 14 votes
    8y

    @Ben Raygor, I'd like to understand more about this comment... 

    Creating an LLC positions yourself to potentially elect to treat your LLC as an S-Corp, (which many investors do for tax savings purposes when they have active income running though that LLC), but until that LLC is S-Corp or C-Corp, it still will result in the same income and expenses being reported on Sch E and/or Sch C of your personal tax return.

    I continue to own my props in my personal name as my accountant has stated that the corp onl results in double taxation. obviously there are other considerations, such as liability but I do have decent insurance. I keep seeing folks go round and round on whether it is worth the LLC. in light of the tax changes, is there an entity that is the most advantageous?

    0Reply
  • Brandon Hall
    OP
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    8y

    @Jocelyn Canfield C-Corps result in double taxation. S-Corps do not as they are pass-through businesses.

    I believe what @Ben Raygor was saying is that LLCs provide the investor with flexibility to potentially elect S or C should your facts/circumstances require such an election. Landlords should rarely, if ever, have rentals in an S or C Corp. 

    We always advise clients that entity structuring for landlords should be primarily focused on asset protection. The tax benefits of moving property into an LLC are nil, even with this new tax plan. So consult an attorney :)

    2Reply
  • Jocelyn Canfield
    Easton, PA · Member since 2013 · 42 posts · 14 votes
    8y
    Originally posted by @Brandon Hall:

    Strategy #2

    If you have the option of being paid on a 1099 basis (as a contractor) rather than a W-2 (employee), and if you make less than $157,500 if single or $315,000 if married, then you need to take a really hard look at making the switch to 1099 pay.

    Doing so will allow you to qualify for the 20% freebie deduction.

    Example: You make $100,000 as a W2 employee. You have no other income, and you're not married. You take the standard devolution of $12,000 so your net taxable income is $88,000.

    On the flip side, you make $100,000 as a contractor. You take the standard deduction of $12,000 AND $20,000 (20% of $100,000). Your net taxable income is $68,000. 

    The tax savings will be roughly $4,500. 

    Obviously this is a very high level example meant for illustrative purposes only. 

    0Reply
  • Jocelyn Canfield
    Easton, PA · Member since 2013 · 42 posts · 14 votes
    8y

    don't forget that as a 1099 you are paying both halfs of the social security and medicare. 7.5% of that goes out the window right there.

    2Reply
  • Austin M.
    Real Estate Professional · Royal Oak, MI · Member since 2012 · 32 posts · 15 votes
    8y
    0Reply
  • Dong Yan
    Real Estate Investor · Irvine, CA · Member since 2016 · 129 posts · 42 votes
    8y

    Brandon,

    ITEM3 State and Local Taxes CAP at 10K apply for property tax from rentals and from Primary residents?

    Thank you so much!

    Stella

    0Reply
  • Brandon Hall
    OP
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    8y

    @Jocelyn Canfield true but a 1099 contractor can be paid through an S-Corp and reduce FICA exposure via paying a reasonable wage. They can deduct health insurance and other ordinary and necessary business expenses. They can max out contributions to 401(k)s at $54k per year.

    Ultimately, it’s a better to have control over your income and the corresponding deductions.

    @dong 

    @Dong Yan does not apply to rentals.

    0Reply
  • Clancy Catelli
    Real Estate Agent · Sequim, WA · Member since 2017 · 64 posts · 39 votes
    8y

    @Brandon Hall In your Strategy #2. IF we are using your exact example, wouldn't receiving a 1099 as a contractor,instead of a w2, force you to pay a 15% self employement tax? I live in washington state and if your running a Sol Prop you have to pay self employement tax on top of normal tax rates. Plus any costs that associate with receiving a 1099. 

    In my situation, i work for my father inlaw building homes. I make about $50k a year W2 from his business. If i got a contractors license and he 1099 me, seems like i would have to pay an additional $7500 in tax that i wouldnt normally. not sure if this is correct. 

    1Reply
  • Blake B.
    Real Estate Agent · Chicago, IL · Member since 2017 · 75 posts · 37 votes
    8y
    My best advice to anyone curious about tax law is to actually read the tax code (no not all of it). You’d be surprised at how small your tax liability can actually be. https://www.law.cornell.edu/uscode/text/26
    0Reply
  • Curt Smith
    Rental Property Investor · Clarkston, GA · Member since 2012 · 2k+ posts · 1k+ votes
    8y

    @Brandon Hall

    I've not heard anything about one of the congress versions moving to characterize rental income via active participation, especially if claiming Professional status, to owe Self Employment tax.  Since this uproar has been missing I'm guessing there's no schenario where owning and managing ones own rentals might owe Self Employment Tax on the rental income?

    Also in this same scenario;  what if the rental owners have delegated management to a Property Management co, does one claim on Sched E "100% active participation" ???  Once we use a PM, are we then obligated to say we are passive?

    What implication does this have on taxes/sched E claiming no active participation?  (assuming using a PM causes this?) 

    Tnx Brandon and other tax folks.

    2Reply
  • Vince DeCrow
    Chicago, IL · Member since 2016 · 94 posts · 87 votes
    8y

    I am not a tax professional, but I have a good grasp on the basics. For anyone reading this thread that wants to know how to capitalize on some of these tax bill implications instead of hearing what the tax changes are, here is my 2 cents.

    If you are in the position to make new investments, one way to do this would be to consider the following strategy. Invest in multi-family real estate (with enough units for it to be considered commercial property) that needs some capital injection in order to become stabilized. Sell your property after you make the capital improvements for a healthy profit. You can make this investment through a partnership or LLC. Whether you have experience adding value to multi-family real estate assets or not, this does not matter. You can invest as a GP of a limited partnership or if you are a passive investor and want to be the LP and have someone you trust do it for you, that is fine too. Single member LLCs can also do the trick if you are an experienced value-add investor.

    Investing this way:

    • Avoids the single family residence mortgage interest cap to take advantage of significant tax interest deductions.
    • Lets you be on the winning side of the age-old argument that "everyone needs somewhere to live".
    • Lets you take advantage of expensing all of your capital expenditures immediately when they are incurred to offset your normal income taxes from your day job and potentially pay no taxes at all in a given year.
      • This was not entirely possible in 2017 because any capital expenditures had to be depreciated over a 27.5 year period for multi-family properties vs expensing immediately.
    • Gives you an effective maximum tax rate on your investment income of 29.6% if you do end up having any income that isn't offset by the capital you put up to do renovations on the multi-family units. This used to be a maximum effective tax rate of 39.6%.
    • Improves your property value through the capital improvement plan you conducted.
    • Puts you in a superior position to take advantage of the positive economic trickle down from the $1 trillion economic stimulus that will be caused by the nationwide reduction in federal corporate tax rates from 35% to 21%.

    -Vince

    1Reply
  • Brandon Hall
    OP
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    8y

    @Clancy Catelli you’re right on the money. But when you receive 1099 income, you can do so in an S-Corp. 

    So you receive $50k in 1099 income but since you’re taxed as an S-Corp, you pay yourself a wage of say $20k. The $20k in wages is subject to the 15.3% tax, so you pay $3,060 in FICA. The business gets to deduct the employer share of FICA, so the remaining $30k of net profit that wasn’t paid out as wages is now $28.5k. Then you deduct health insurance of $5k and you get to write off business expenses for maybe another $5k. 

    So now we’re down to $20k in wages and $18.5k in business income. We then contribute to a 401k at the employee $18k max as well as the employer 25% of your W2 - basically you are able to contribute your entire $20k of wages to the 401k.

    This leaves you with $18.5k of reportable income.

    And now we have this freebie tax deduction. 20% of your combined qualified business income which does not include wages you pay yourself. So you get another $3,700 deduction.

    And once we factor in your standard deduction of $12k, you’re at $2,800 in taxable income. This results in income tax of $280.

    Your total tax paid was the FICA of $3,340.

    —

    Compare that to earning a W2 wage of $50k. Your FICA tax will be $3,825. 

    You max out the 401k at $18k. Now we’re down to $32k. We get the standard deduction of $12k which leaves us with taxable income of $20k. That yields another $2,200 in taxes.

    —

    So W2 earner pays $6,025. The 1099 pays $3,340.

    —

    Again, this is an illustrative example. Everyone’s situation is unique and numbers will differ greatly from person to person. 

    1Reply
  • Vince DeCrow
    Chicago, IL · Member since 2016 · 94 posts · 87 votes
    8y
    Originally posted by @Hernell D.:

    Brandon Hall thank you! What do you think the biggest change for real estate investors will be?

    Hey Hernell,

    In my opinion, the biggest change for real estate investors will be the corporate tax rate deduction from 35% to 21%. The macro effect from this has the potential to be big for real estate. Real estate values tend to move with the overall economy, with all else equal. The corporate tax cut is estimated to create about $1 trillion in economic stimulus over the next few years. The annual GDP in the US is around $20 trillion. If the economy booms, real estate investor's existing pockets will become BiggerPockets.

    -Vince

    2Reply
  • Brandon Hall
    OP
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    8y

    @Curt Smith SE tax on rental income was removed. Sigh of relief.

    @Vince DeCrow I’m confused by a few of your thoughts/comments.

    1. Buying a property with more units does not help classify it as commercial from a tax perspective. A 1,000 unit property is still residential. Maybe you are talking about forcing appreciation on the cap rate for properties with >4 units?

    2. There is no mortgage interest cap on single family homes as long as they are rentals. Only if it’s your primary or secondary residence.

    3. You cannot immediately expense capital expenditures with a useful life of greater than 20 years. This is true in current law and the proposed bill. So if you improve plumbing, electricity, HVAC, and other components affixed to the structure, you can’t expense them as they will have useful lives of 27.5 years.

    1Reply
  • Clancy Catelli
    Real Estate Agent · Sequim, WA · Member since 2017 · 64 posts · 39 votes
    8y

    Thanks @Brandon Hall Looks like you talked me into creating an S-corp! It would be beneficial for flipping houses also. Iv been buying houses, fixing them, then living in them for a while before selling them in order to get around having to have a contractors license. Might be my next step to set up an S-corp and start writing things off.

    1Reply
  • Mark Zingale
    COLORADO SPRINGS, CO · Member since 2017 · 2 posts · 1 vote
    8y

    Won't lowering my business income after all expenses by 20% also lower my state tax liability?  In Colorado we use the federal taxable income to determine state tax liability.

    0Reply
  • Brandon Hall
    OP
    CPA · Raleigh, NC · Member since 2013 · 1k+ posts · 2k+ votes
    8y

    @Mark Zingale in some states, yes. But not all states.

    0Reply
  • Kurt Kwart
    Specialist · Atlantic City, NJ · Member since 2013 · 431 posts · 170 votes
    8y

    @Brandon Hall any thoughts on paying  2018 taxes this year on rental and personal property to try and stay under the 10k limit for next year?

    0Reply
  • Thom H.
    Investor · Central Virginia Area, VA · Member since 2012 · 80 posts · 28 votes
    8y

    I've read through this entire post, and it's fantastic. Thank you to all who posted. 

    There's one quick question that I don't find fully explained (at least I hope I didn't miss it).  I understand the 20% pass through is based on taxable income (net Schedule E amount). Is it yet understood whether the new 20% pass through deduction will occur at the Schedule E level or post AGI as a deduction on page two of the 1040 form? Just trying to understand if the 20% is "above line calculation" (included in calculating AGI) or "below line"? This could be important in calculating MAGI in 2018 for ACA subsidy calculations for some. Thanks in advance for any responses. 

    3Reply
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