Even with all of the potential upcoming tax changes bouncing around, one thing we know fairly for certain is that 2016 taxes will not change. Although nothing is set in stone yet regarding 2017, we do have a few ideas of how the possible changes may affect investors. With only a few more weeks before the new year, there is still an opportunity for some great year-end tax planning in light of the potential tax changes that may take place in 2017.
Below is a “to-do vs. to-defer” action plan for the fast approaching end of the year.
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According to the potential tax changes, some investors may see a decrease in their future federal tax rates. Under our current tax code, the top tax bracket is 39.6%, but under the proposed changes, the top bracket may be reduced to be 33%. That is great news for many of the high-earner investors who are currently in the 35% or 39.6% bracket. In addition, many people in the 28% tax bracket may drop to a 25% rate under the new proposal. With that said, it may make sense to focus on reducing your 2016 income prior to year-end since your rate is likely higher now. Essentially a deduction at a 39.6% tax rate is more valuable than at a 33% tax rate, so start spending!
To reduce income this year, you may want to look into pre-paying some expenses or investing more assets into your real estate now instead of waiting until after the new year. Maybe you should pay that second half of the property tax bill for your rentals now instead of waiting until it is due next February. Maybe it’s time to do that remodel or major repair that you have been holding off on starting. Need new computers for the office? Now is the best time to order them. If you are at a 39.6% tax bracket then for every $1,000 of expenses, you may be saving almost $400 in taxes.
Luckily, some decisions can be put off until later, one being retirement contributions. If you have an IRA or a Solo(k), then you may want to consider maxing out your deductions this year. Depending on your entity structure and how you pay yourself, you may have all the way up until September or October of 2017 to decide how much you want to contribute. This is great because you may get a better insight into some of the upcoming tax changes before you make the contribution decisions. Keep in mind, though, that if you work a W-2 job, you only have until the end of 2016 to maximize your employee 401(k) contributions. These are not extended to October like some of the self-employed retirement accounts.
One of the proposed changes that may actually increase taxes for taxpayers is the possibility of a limit on certain itemized deductions. Common itemized deductions claimed include things like primary home mortgage interest, property taxes, DMV fees, out-of-pocket medical expenses, and charitable donations. To protect yourself, it may make sense to prepay or pre-fund some of these items now. For example, if you have a charity you are passionate about, 2016 may be the year when you make a large donation to lock in that tax deduction. For some investors with larger portfolios looking to make a significant donation, this may be the year to consider setting up a charitable trust where you can fund the trust with your rentals, pledge the future rental income to charities of your choice, and take a large deduction up front in 2016. The best part of some of these trust structures is that it may be possible to retain ownership of the rental property at the end of the trust terms.
Related: The Ultimate Guide to Real Estate Investment Tax Benefits
Don’t put off until tomorrow what you can do today — unless, of course, there are better tax incentives tomorrow. Because of the potential tax rate decrease in 2017, hold off on collecting income if you can. That doesn’t mean don’t deposit checks you already have on hand. Those have already been “received.” Instead, put off billing a client until after the new year — or if you haven’t received a late payment yet, wait until the new year to send out a reminder.
The new plan will likely leave capital gains taxes similar to the current rates; however, the Net Investment Income Tax may be abolished under the new proposed plan. This is a 3.8% tax on investment income earned by those who make over $250k if married and $200k if single. Rental income, interest income, and capital gains are generally subject to this additional tax, so this may result in some significant tax savings for real estate investors in 2017 if this change is passed.
Therefore, if possible, try to defer interest income from note investments to 2017. Alternatively, if you are considering selling a property, wait until January 2017 to close on the sale. This way you could possibly be looking at a lower tax rate and no net investment income tax, which could be around a 10% tax break if you are a high income investor.
Another proposed change is a 15% tax rate on LLCs and S Corporations, but don’t run out just yet to form a new legal entity. The changes are still somewhat vague in how this income would be taxed. While 15% sounds like a great deal compared to a 33% bracket, we don’t have details on how exactly this tax reduction will be implemented. For example, under current law, distributions from a pass-through entity (LLC and S Corporation) are tax-free. This is a great way to extract profits from your business without getting hit with double taxation like you would with a C Corporation. It isn’t clear yet, though, if the new potential plan would incorporate double taxation for pass-through entities or not. So if you’re on the fence about forming an entity, it may be beneficial to wait a little longer, and as always, make sure you consult with your tax advisor prior to forming or dissolving any legal entities.
With only a few weeks left, make sure to implement as many of these last minute tips as possible to keep your tax bill low for 2016. Although we don’t have all the details on tax plans for 2017, we do know there are going to be some changes. We will keep you updated once we know more. Until then, have a happy holiday season!
Are you changing anything in light of proposed changes to tax laws?
Let me know with a comment!