Similar to other industries, the Tax Cut and Jobs Act (TCJA) has impacted the real estate market, especially for investors. As the real estate industry constantly responds to market-driven factors, modifications created by tax reform allow the industry to remain highly attractive for investors and business owners. Investors remain hopeful that the TCJA will remain active for the next eight to ten years permitting them to advance their investments confidently with the newly implemented lower tax brackets. New regulations created by tax reform reflects a shift down in percentage of each tax bracket as well as a larger range of income within each tax bracket. For example, married taxpayers filing jointly with taxable income of $300,000 would have a marginal tax rate of 24% in 2018, compared to 33% in 2017. Additionally, the highest tax bracket drops from 39.6 percent to 37 percent with the floor of that bracket increasing from $470,700 to $600,000. Ultimately, these regulations will affect capital gains or the profit made when a property is sold. These reductions will impact the investor’s short-term capital gains, as they will be responsible for paying taxes based on their current tax bracket. Long-term capital gains will remain the same at 0%, 15% or 20% also depending on the tax bracket. Other changes implemented by tax reform include: adjustments in bonus depreciation, incentives for pass-through entities and a cap on state and local tax (SALT) and mortgage interest deductions.
Adjustments to the bonus deprecation rule is one of the numerous changes brought upon by tax reform that could significantly benefit real estate investors. Through bonus depreciation, investors can deduct a predetermined percentage of the cost of qualified tangible business property when they acquire and place a property in service. TCJA allows first-year bonus depreciation to increase to 100%, formerly 50%, for qualifying assets acquired and placed in service between September 28, 2017 and December 31, 2022. After this time period closes, the IRS will phase out the first-year bonus depreciation rule over the following five years. Lastly, starting at the beginning of 2018, changes in bonus depreciation are now applied to purchases of both new and used properties, previously only new.
In addition to bonus depreciation, the TCJA created a new section in the Internal Revenue Code, Section 199A, or the Qualified Business Income Deduction (QBID). Section 199A allows business owners not taxed as C corporations (S-Corporations, Parnerships/LLCs, Sole Proprietors and possibly Schedule E rentals) to deduct 20% of qualified business income subject to limitations. Determining if real estate investments and rental properties qualify for QBID is complex and can vary on a case-by-case basis.
The TCJA also created modifications to the state and local tax (SALT) and mortgage interest deductions. While these changes are less attractive to homeowners, they will have no effect on residential rental properties. Currently, the TCJA states that SALT deductions are limited to $10,000 for taxpayers who take itemized deductions on Schedule A, however the deduction does not apply to property used for trade or business. In addition, the interest deduction on new mortgages, for primary or secondary homes, taken out after December 14, 2017 are limited to $750,000 (formerly $1 million). Taxpayers who took out a mortgage prior to this date can continue to claim interest on up to $1 million in principal on loans before being phased out. Lastly, investors are no longer able to deduct interest on home equity loans unless they are used to acquire or improve a qualified property.
Like all industries, real estate investing has been directly affected by the TCJA. The lowered tax brackets and new benefits for pass-through entities has further bolstered an already strong real estate market. Understanding changes and how they could affect your investments is critical to real estate professionals. We encourage investors to meet with a member of our team to discuss these changes and plan for the future.