President Trump signed the Tax Cuts and Job Act (“Act”) in December 2017 implementing the largest revision to federal income tax laws in decades. Nearly every industry is feeling the impact. For real estate trusts and taxpayers involved in the real estate business, the changes are significant in six key areas.
1. Tax Rates – For tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, seven tax rates apply for individuals: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Not only did the highest brackets decrease, but the level of income you must reach before jumping to the next bracket also increased.
The Act generally retains present-law maximum rates on net capital gains and qualified dividends. It retains the breakpoints between the 0% and 15% rates and between the 15% and 20% rates that existed under the pre-Act law but indexes them for inflation using C-CPI-U in tax years after Dec. 31, 2017.
2. Trade or Business Deduction – This is one of the most beneficial provisions included in the tax legislation for small businesses. Generally, for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026, the Act adds a new section, Code Sec. 199A, “Qualified Business Income,” under which a non-corporate taxpayer, including a trust or estate, who has qualified business income (QBI) from a partnership, S corporation, or sole proprietorship can deduct 20% of the lesser of (a) combined QBI, or (b) taxable income, excluding net capital gains. Combined QBI includes dividends from a qualified real estate investment trust (REIT) and income from qualified publicly traded partnerships. There are, however, many limitations and phase-outs depending on your income level and the industry involved.
3. Depreciation Provisions – For property placed in service in tax years beginning after Dec. 31, 2017, the maximum amount a taxpayer may expense under Code Sec. 179 is increased to $1 million, with the phase-out threshold amount increased to $2.5 million. Furthermore, the Act expanded the definition of Sec. 179 property to include personal property used predominantly to furnish lodging and certain qualified nonresidential real property (such as HVAC, roofs, fire protection, and alarms and security systems) placed in service after the date the building was first placed in service.
The Act eliminates the separate definitions of qualified leasehold improvement, qualified restaurant, and qualified retail improvement property and replaces them with qualified improvement property which qualifies for a 15-year life. The requirements that the improvement must be subject to a lease and placed in service more than three years after the building was first placed in service have been eliminated.
For qualifying assets acquired and placed in service after Sept. 27, 2017, 100% bonus depreciation can be utilized. Bonus depreciation can now be used on either new or used assets and is scheduled to start phasing out after 2022.
4. Interest Expensing Limitations – Business interest is limited to 30% of the company’s adjusted taxable income for tax years beginning after Dec. 31, 2017. Adjusted taxable income is computed without regard to deductions allowable for depreciation, amortization, or depletion. Companies with less than $25 million of gross receipts for the three prior tax years, however, may be exempt from this limit (there are several limitations to this exemption). Disallowed interest can be carried forward indefinitely. Real property trades or businesses can elect out of the provision if they use ADS to depreciate applicable real property used in a trade or business.
5. Loss Limitations – For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the Act provides that noncorporate taxpayer’s “excess business loss” is disallowed. An excess business loss for the tax year is the excess of aggregate deductions of the taxpayer attributable to the taxpayer’s trades and businesses, over the sum of aggregate gross income or gain of the taxpayer plus a threshold amount. The threshold amount for a tax year is $500,000 for married individuals filing jointly, and $250,000 for other individuals, with both amounts indexed for inflation. In the case of a partnership or S corporation, the provision applies at the partner or shareholder level.
For losses arising in tax years beginning after Dec. 31, 2017, the net operating loss (NOL) deduction is limited to 80% of taxable income. NOLs can be carried forward indefinitely.
6. Individual Itemized Deductions – For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the standard deduction is doubled ($24,000 for married individuals filing a joint return, $18,000 for head-of-household filers, and $12,000 for all other taxpayers) and the deduction for personal exemptions is effectively suspended by reducing the exemption amount to zero.’
• State and Local Tax Deduction – Under the Act, the deduction for state and local taxes is limited to $10,000 ($5,000 for married taxpayers filing separately). Foreign real property taxes may not be deducted.
• Mortgage and Home Equity Indebtedness – For tax years beginning after Dec. 31, 2017, and before Jan. 1, 2026, the deduction for interest on home equity indebtedness is suspended, and the deduction for mortgage interest is limited to underlying indebtedness of up to $750,000 ($375,000 for married taxpayers filing separately). This new lower limit doesn’t apply to indebtedness incurred before Dec. 15, 2017 or to refinanced existing indebtedness incurred before Dec. 15, 2017 so long as the new debt amount does not exceed the amount of the refinanced debt.
Another notable change, the Tax Act also limits the nonrecognition of gain for like-kind exchanges to real property that is not held primarily for sale. Therefore effective Jan. 1, 2018, any gain from the trade-in of personal property (i.e. equipment and vehicles) will be taxable. However, under a transition rule, the pre-Act like-kind exchange rules apply to exchanges of personal property if the taxpayer has either disposed of the relinquished property or acquired the replacement property on or before Dec. 31, 2017.
This list is by no means all-encompassing. For a more comprehensive list of the changes included in the Act, please download our FREE E-book below.
For specific questions on any of the changes listed above or how the Tax Cut and Jobs Act may impact your real estate business, please contact your MarksNelson Advisor at (816) 743-7700.