By Thomas B. Eriksen
This article originally appeared in the January 19, 2018 edition of the Daily Journal of Commerce Oregon.
The Tax Cuts and Jobs Act passed by Congress and signed into law by President Trump this past December will have a significant impact on the real estate industry in 2018. Residential real estate, commercial real estate, and real estate professionals will all feel the impact of the new tax law as we head into the new year. While many of the most impactful proposed changes in the tax law did not make it into the final legislation passed by Congress, many did. This provides a planning opportunity for those knowledgeable about the changes, and pitfalls for those who are not.
Mortgage Interest Deduction Cap Reduced. While the House version of the bill attempted to lower the cap on mortgage interest deductions from $1,000,000 to $500,000, the final version of the bill only reduced the cap to $750,000. Interest deductions on existing loans over the new $750,000 cap are grandfathered in up to the prior $1,000,000 cap, as are interest deductions on refinancing of any existing loan over the new limit (again up to the prior $1,000,000 cap), so long as the new mortgage does not exceed the existing balance of the loan being refinanced. Interest on home equity loans is no longer deductible unless the loan proceeds are used to substantially improve the home.
State and Local Tax Deductions. As has been widely reported, the new tax bill limits the deductibility of state and local income and property taxes (and sales tax) to $10,000 each year. This single $10,000 limit applies whether the taxpayer is single or married.
Moving Expenses. Except for members of the United States Armed Forces, the final tax bill repeals the deductibility of moving expenses.
Most real estate professionals and industry experts anticipate these changes will slow the growth of home prices in 2018. The industry consensus anticipates a nationwide 1% – 3% growth in real estate values in 2018. As always has been the case, individual markets will vary.
Like-Kind Exchanges. The final tax law bill retained Section 1031 like-kind exchanges for real property including land, buildings, and improvements. However, the final bill repealed like-kind exchanges for personal property, including art work, vehicles, and equipment. In the past, many tax deferred like-kind exchanges included both real and personal property. Now, careful allocation of the purchase price between personal and real property is necessary to minimize the tax consequences of such transactions.
Tax Credit. The 10% Historic (Rehabilitation) Tax Credit for buildings constructed prior to 1936 was repealed. The 20% credit for certified historic structures was retained. However, the tax credit was modified so that the credit must now be claimed ratably over a five-year period beginning in the year in which the rehabilitated structure is placed in service.
Pass Through Deduction. Income passed through to individual taxpayers from partnerships (LLCs), S corporations, and sole partnerships (i.e., single member LLCs) is now generally entitled to a 20% deduction for “qualified business income.” [See the discussion below for the definition of qualified business income as it relates to real estate activities.] Since most real estate business is conducted through LLCs, most real estate businesses should be able to take advantage of this deduction.
Real Estate Professionals
REIT Dividends. Individual taxpayers may now deduct 20% of “Qualified REIT Dividends.” Qualified REIT Dividends include REIT dividends other than those designated as capital gains dividends or dividends that qualify for capital gains rates. For individual taxpayers, the impact of this deduction is that the tax rate for qualified REIT Dividends is 80% of the individual’s tax rate that would otherwise apply for tax payments. In the highest tax bracket (37%), the tax rate for Qualified REIT Dividends after the 20% deduction becomes 29.6%.
Qualified Business Income Deductions. Similar to the 20% Qualified REIT Dividend deduction, individual taxpayers may deduct up to 20% of “Qualified Business Income” attributable to a qualifying real estate trade or business. Qualified Business Income generally includes net income and gains from a qualified trade or business, which includes any business other than certain specified service businesses. Since a traditional real estate business involved in the renting of real property and developing real property is not included on the “certain specified service business” list, income and gains from a real estate trade or business are eligible for the 20% Qualified Business Income Deduction.
In addition to these changes, there are many technical changes for depreciation of improvements on real property, expensing of business assets, loss limitations, and business expense deduction limitations. While most of these changes apply to taxable years beginning after December 31, 2017, some changes begin as early as September 27, 2017. Suffice it to say that proactively working with your tax adviser early in the year could pay dividends as early as your 2017 tax filing.
Thomas B. Eriksen is an attorney in Jordan Ramis PC’s Business Law practice group. He represents business and corporate clients in all aspects of business operations. You can contact him at 503-598-5590 or by email at firstname.lastname@example.org.