Truth told, the new tax reform laws affect most Americans. One might read this and think, “I’m not an investor in real estate, how could that be?” On December 22, 2017, President Trump signed the Tax Cuts and Jobs Act (TCJA) into law. Investors, homeowners and renters alike will feel an impact.
The purpose of this article is not to break down the tax bill piece by piece. By the end, the reader should have a better idea of how changes to tax breaks and deductions will have a direct or trickle down effect.
This blog ends on a high note and saves the best news for last. To start, here is an overview of how tax changes might have a negative effect on real estate investments.
Property Tax Ceiling
Prior years saw an uncapped property tax deduction. In addition, property owners could file an unlimited income tax or sales tax deduction (but not both).
The 2017 tax reform bill brought big changes to these deductions. State and local income taxes (SALT) or state and local sales taxes, plus real property taxes were capped. Between income, sales and property taxes, filers may only deduct up to a combined amount of $10,000 (single or married). Married filing individuals may only deduct up to $5,000. This would make it seem married couples are being penalized since unmarried “singles” can deduct up to $10,000, or $20,000 combined.
A recent report from CNN Money revealed that 4.1 million Americans pay more than $10,000 in property taxes. High income tax states (New York, Connecticut, New Jersey, Wisconsin, Illinois, California) will feel the biggest hit from this change. For many residents of these states, a cap on a combined deduction of income, sales and property taxes will have a pronounced negative affect.
To sum it up: The ability to deduct large sums has dwindled for individuals in high income and high property tax states. Fortunately, Colorado residents will feel less of an impact. Reports show that Colorado homes are taxed at some of the lowest rates in the country (0.52 in CO vs. 1.15 Nationwide).
What are possible repercussions?
For home investors in a high-income and property tax state, the SALT limitation will make home ownership unaffordable for a handful of people. We may see a trend toward renting versus owning.
For current renters, this means a more competitive rental landscape. In mountain areas including Vail, Breckenridge, Frisco, and Winter Park where long-term rentals are already limited, this could create a greater housing strain for locals.
For many landlords this is a positive pendulum swing. Higher rental demand will ensue. Greater need combined with the new 20% business deduction (covered later) will result in deeper pockets for most landlords.
This chain of events leads analysts to predict an uptick of homes on the market. Many houses will go up for sale by those who can no longer afford the tax increase. Residential real estate investors will see an increase in business - more homes on the market and more people with a hope to rent, not own. As a real estate investor, this tax reform topic could be seen in a positive or negative light.
Limitations on Mortgage Deductions
Prior to December 22, 2017, when President Trump signed the TCJA into law, home mortgage interest rates were fully deductible up to $1,000,000 (IRS Publication 936). Now, mortgage interest is deductible on the first $750,000 (or $375,000 if married filing separately) for primary and secondary residences. In order to deduct mortgage interest, your residence must be a “qualified home.” The IRS defines qualified homes as; “a main or second home” (houses, condominiums, cooperatives, mobile homes, house trailers, boats, or similar property that has sleeping, cooking and toilet facilities) are covered by this definition.
For investors with more than two homes, mortgage interest past the second home is not deductible as this property is considered personal interest.
Tax filers with a mortgage prior to December 15, 2017, are grandfathered in to the previous interest tax law. Individuals that fall into this category can continue to deduct home mortgage interest on up to $1,000,000 (or $500,000 if married filing separately).
Interest on a home equity loan is no longer deductible...
Now for the good news. Real estate investors, listen up!
20% Pass-Through Deduction
Qualified income from a pass-through business is now eligible for a 20% deduction. To refresh, legal institutions define pass-through business taxation as follows: “How owners of a business pay tax on income derived from that business on their personal income tax returns. Pass through taxation applies to sole proprietorships, partnerships, and S-Corporations.”
How does that work?
For example, a real estate investor generated $30,000 in net taxable income from a rental property this year. Under the TCJA, that individual can deduct 20% of his or her net taxable income. $30,000 x 20% = $6,000 deduction eligible income on one’s personal tax filing if this real estate income emanates through a pass-through business (LLC, S-Corps, etc.).
It is possible that this deduction could be limited. For those that make more than $207,500 single or $315,000 married filing jointly the full 20% deduction may not apply.
Increase in Bonus Depreciation
Home improvement gurus, HGTV fans and DIY-ers rejoice! Under the TCJA, bonus depreciation increased. Originally 50%, people can now write off 100% of costs for land improvements or personal property with a useful life less than 20 years. This includes new and used assets.
Certain expenses such as landscape, parking space, fences and irrigation systems qualify as land improvement costs. A few examples of qualified personal property expenses include equipment, carpet, tools and appliances. Check out the Coldwell Banker blog for a few tips and tricks on landscaping and roofing improvements.
It is important to remember that assets might incur a depreciation recapture tax upon sale.
Tell Me About The Future
It is possible to see these tax cuts and breaks overturned. How? In the event the party of political opposition takes control of office. If this happens, we may see changes or a reversal. Until then, expect these new tax laws to affect real estate investments from 2017-2025.
When you choose to sell or buy with Coldwell Banker Mountain Properties, you can do so with confidence. Market changes and tax laws are confusing. Our extensive knowledge and expertise will put you at ease with the process. Together, we can navigate real estate trends to maximize your investment.
Contact us with questions or for more information!
DISCLAIMER: This article is meant to offer a layperson's perspective on how the TCJA might affect certain types of homeowners. To see how you might impacted by TCJA, please talk to your CPA.
By Coldwell Banker