Written by Rita Steele, Joanne Chang and Artika Wadhwa
Will you be affected?
With the passing of the Tax Cuts and Jobs Act came the questions. Lotsssssss of questions. From clients, family members, colleagues and from my own confused interpretations of what the media was throwing out there during the final weeks of 2017. But the questions could ultimately all be cut down to one ultimate concern: “will I be affected?”
In an effort to assure our clients and all of you out there with plans to make some real estate related moves in 2018, here is our brass tacks guide to the actual changes we will be seeing in your Rhode Island real estate dealings until Congress changes things up again.
RI State and Local Tax Deductions.
Taxpayers who itemize their taxes can deduct state and local property and real estate taxes. The deduction has been capped at $10,000.
This change applies to both married and single filers.
Approximately 33% of Rhode Island tax returns deduct state and local tax payments, with the average size of these deductions being $12,140. So this one is going to pinch up to a third of RI tax payers.
The Mortgage Interest Deduction.
For new loans, the limit on deductible mortgage debt has been reduced to $750,000 (down from $1,000,000). If you obtained your home loan prior to December 14, 2017, your deduction up to $1,000,000 is grandfathered in.
You can still refinance preexisting mortgages up to $1,000,000 and continue claiming your interest deduction – so long as your new loan does not exceed the amount of the old one.
You can still take this deduction on your second home as well.
Grey area. The Bill repeals the deduction for interest paid on home equity debt (or HELOC). It appears that interest on home equity loans will now only be deductible if the proceeds are used to “substantially improve” your property. I.e. interest on using home equity lines to pay your kid’s college tuition is no longer going to be deductible. What qualifies as “substantial improvements” has yet to be clarified by the IRS. This is a grey area of mixed interpretations – if you planned on deducting HELOC interest paid, you will need to determine with your accountant how the new law affects you.
Standard Deduction v. Mortgage Interest Deduction.
If you don’t itemize, the standard deduction is the amount that you can deduct from your income before calculating your tax liability. For 2018, this amount has increased to $12,000 for single filers and $24,000 for joint filers. (i.e. it has almost doubled).
By increasing the standard deduction, most taxpayers will no longer need to bother with itemizing to deduct mortgage interest and property taxes as outlined above. (So you will now only bother with the itemized deduction process if the interest you paid on your mortgage and all the rest of your deductible expenses are greater than the new standard deduction.)
Pass-Through Entities Deduction
So this one is a biggie for a lot of investors – the new bill lowers the tax rate on pass-through entities (e.g. LLCs, partnerships) where owners were previously taxed at individual marginal tax rates on their share of the business income. Now owners of pass-through entities, e.g. an LLC that owns commercial or investment real estate, making less than $157,500 for single filers (or $315,000 for joint filers) will be able to shave 20% off earnings before paying taxes on those earnings. The deduction phases out at income levels above these thresholds. There are many more nuances around this, but the new tax bill favors investing in real estate through pass-through entities in a very big way.
Good news for all of our investors – 1031 like kind exchanges rules are staying the same so far as real property is concerned. (With 1031 exchanges, you can defer the capital gains tax consequences of a sale by reinvesting the proceeds of your sale into a new property.)
The law is staying the same. Capital gains are the profits realized from the sale of real estate, among other assets. This means that you can still make tax-free profits of $250,000 for single filers, or $500,000 for joint filers, every time you sell a home that you have lived in for two of the five years prior to the sale.
A “carried interest,” is a financial interest provided to managers or developers as an incentive to aid/maximize performance of a partnership’s assets and/or investments. In the context of real estate, it is arguably an incentive to promote development because it enables real estate investors to pay a lower (20%) capital gains rate on their development income rather than higher ordinary income tax rates. The fact that this law was not eliminated or modified is a subject of strong debate. But, developers enjoy it while you have it.
Rental Income Subject to Self-Employment Tax.
The proposed bill would have subjected rental income to self-employment taxes. As our local rental market already struggles with high tax rates, this would have been a hard hit here. But this didn’t become a thing. (Again, phew).
Historic Rehabilitation Tax Credit.
The new bill retains the current 20% credit for certified historic structures. As strong advocates for adaptive reuse and restoration, we are happy to see this reaffirmation that the deep and multifaceted benefits of such preservation are still considered to be sound policy.
The above just touches on what we consider to be the biggest changes to our tax laws as they pertain to home ownership and real estate investment. But tax law is complicated, and other changes may have more of an effect on you than what is here. Make sure you consult with your accountant or a tax professional to understand what the changes really mean for you.
Making real estate moves in 2018? Contact us today at firstname.lastname@example.org.