Wealth Planning Advisory – February 2018
How Real Estate Is Impacted By The Tax Cuts And Jobs Act
When President Trump signed The Tax Cuts and Jobs Act (TCJA), it represented the most extensive revision of the Internal Revenue Code since 1986. The following are a few of the key provisions in TCJA that impact real estate for taxable years 2018-2025:
- Mortgage Interest Deduction. TCJA reduces the acquisition debt that qualifies for the mortgage interest deduction. For example, the acquisition debt is reduced from $1,000,000 to $750,000 for married taxpayers filing jointly. However, for acquisition debt incurred before December 15, 2017, the $1,000,000 limit still applies. The interest deduction for home equity loans is still available for loans used to buy, build, or substantially improve the home subject to certain restrictions.
- New Deduction for Pass-Through Trades or Businesses. TCJA provides a deduction of 20% of the qualified business income of pass-through taxpayers such as partnerships and S Corporations. The ability to take the deduction is limited for taxpayers above certain thresholds to the greater of: 50% of W-2 wages or 25% of W-2 wages plus 2.5% of the unadjusted basis of qualified business property. In addition, the deduction is not available to certain specified service trades or businesses such as accounting and law firms when their taxable income exceeds $415,000 in a taxable year. It is important to note that the deduction is taken at the taxpayer level not the trade or business level.
- REIT Dividends. Non-corporate taxpayers who receive ordinary REIT dividends are eligible for the 20% deduction of qualified business income. Ordinary REIT dividends are dividends other than capital gain dividends and qualified dividend income. REIT dividends receive favorable treatment because the 20% deduction is available without regard to the limitation W-2 wage and unadjusted basis of qualified property limitation, and without regard to the limitation placed on certain specified service trades or businesses noted above. The bottom line is that the 20% deduction reduces the maximum tax rate on REIT dividends from 37% to 29.6%, excluding the additional 3.8% Medicare Tax on investment income.
- Business Interest Deduction. Business interest is any interest paid or accrued on indebtedness property allocable to a trade or business. TCJA limits a taxpayer’s deduction for business interest in any taxable year to the sum of the taxpayer’s business interest income and 30% of the taxpayer’s adjusted taxable income for the taxable year. Before 2022, adjusted taxable income is defined as “earnings before interest, taxes, depreciation, and amortization” (EBITDA). Thereafter, it is defined as “earnings before interest and taxes” (EBIT). The deduction limitation applies to taxpayers with average annual gross receipts of more than $25,000,000 for the 3 taxable year period ending with the prior taxable year. Also, real estate trades or businesses can make an irrevocable election to be exempt from the limitation. The tradeoff for this election is that the taxpayer must use the alternative depreciation system (ADS), which may lengthen the depreciable lives of the real estate.
This Planning Advisory is not intended as tax or legal advice. Also, it is not intended to offer penalty protection or to promote, market, or recommend any information contained herein. Before acting on the information in this Planning Advisory, a competent professional should be consulted.