[REN #415] Tax Reform Could Benefit Real Estate Investors

Picture of congress for Real Estate News for Investors Podcast Episode #415

Get ready for more loopholes… The new tax bill looks like it will be no less complicated than it’s already been, and appears to offer more ways for high-income earners to reduce their tax liabilities with creative accounting. You’ll need a good CPA for 2018 because Turbo Tax is not going to share the secrets of the wealthy!

The House and Senate passed their versions of tax reform, then had to reconcile their differences into one final bill. That conference happened on Friday. If the new bill passes Congress this week, it could be signed into law by President Trump as early as Tuesday.

How will the proposed changes affect real estate investors?

According to the New York Times, real estate investors and tech companies could benefit tremendously. Here’s a long list of how the amazing real estate tax benefits already in place may be protected:

1. The new bill does not appear to change our ability to defer taxes through the 1031 exchange of like-kind property. This was up for debate under Obama’s administration. That means it will likely still be a great time to sell high priced, low cash flow properties, and trade them tax deferred for low cost, high cash flow properties in emerging markets.

2. The mortgage interest deduction will likely be capped at $750,000 on new mortgages. The limit will probably remain at $1,000,000 for mortgages taken out before Dec 15, 2017. The cap applies to your primary residence plus one other home. Deductions for interest on home equity debt will likely be eliminated – if the debt was not related to home improvements.

3. There appears to be no change to the capital gains rates. If you hold property for less than a year, you would still pay short term capital gain on the profit, which is at ordinary income rates. But if you hold the property for more than one year before selling, the profit is treated as long-term capital gain and taxed at rates up to 20%.

4. There appears to be no change to the exclusion of gain from the sale of your primary residence. This means you can still exclude (meaning not pay tax) on up to $250,000 of gain if you sell your home, or get $500,000 tax-free if you’re married – as long as you have owned the property and lived there for at least two of the past five years. There was talk of changing it to 5 of the past 8 years, but it looks like that won’t happen.

5. Here’s a big one,  pass-through entities could get a nice tax break. Most real estate investors hold their assets in Limited Liability Companies. LLC’s along with S-Corporations, are called “pass-through” entities because the money earned by the partnership is taxed at the individual’s rate, not at the corporate level.

High income earners in the top tax bracket of 39.6% would have to pay that 39.6% on profits received from their LLC or distributions from an S-Corp. Under the new bill, the profits would be taxed at a much lower rate – approximately 29.6%.

The way it appears to be written is that owners of pass-through companies AND sole proprietors will be taxed at their individual tax rates minus a 20% deduction. This would lower the tax rate for business-related income, but is subject to limitations. For example, this deduction would be disallowed for certain professionals (doctors, dentists, accountants, attorneys) who earn more than $157,500 as individuals or $315,000 for married couples filing jointly.

6. Tax changes to C-Corporations is the big news of the day. Larger corporations have had to pay a corporate tax rate of 35% before shareholders get paid their dividends. The shareholders then pay tax on the income they receive from those dividends. This “double taxation” of C-Corporations is why many companies keep their earnings off-shore. The new corporate tax rate appears to be reduced to 21% from 35% in the hopes that more companies will move operations and employees back to U.S. soil.

7. The standard deduction may increase to $12,000 from $6,500 for individuals and $24,000, up from $13,000, for couples filing jointly.

8. Personal exemptions would disappear. Miscellaneous itemized deductions that exceed 2% of your AGI would also be eliminated (things like home office expenses and tax preparation services.)

9. Medical expense deductions might be lowered from 10% of your AGI to 7.5%.

10. The Obamacare Individual Mandate will likely be eliminated. In other words, you will not pay a penalty if you do not have health insurance.

11. The “death tax” is proposed to increase from $11 million for a married couple to $22 million, so there would be big benefits to rich kids.

12. And finally, if you had any question about who this tax reform benefits, private equity managers will probably get to keep their carried interest loophole, allowing them to count the majority of their pay at long-term capital gains rates. The president attacked wealthy investment managers for this very thing during his campaign but, they get to keep their unusual benefits in tact…

All this won’t be set in stone until it passes in Congress and then gets President Trump’s signature. That’s expected to happen on Tuesday, but anything can happen.

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