For the most part, US tax laws have been favorable for real estate investors and developers. This will certainly continue under President Trump and the Tax Cuts and Jobs Act that went into effect on January 1, 2018.
Tax Rates: To start, the TCJA lowers tax rates for both individuals and corporations. Beginning in 2018, the Act reduces the highest marginal rate for individuals from 39.6% to 37% on ordinary income. The new law also creates a flat 21% tax rate for C Corporations. While the lower individual rates will expire after 2025, the change to the corporation rate is permanent.
Pass-through Entities: In addition to lower tax rates, the TCJA has also created a new tax deduction for income earned through so-called pass-through entities (sole proprietorships, limited liability companies, partnerships and S corporations). The 199A deduction, as it is commonly known, can be as much as 20% of “qualified business income” earned through these pass-throughs, subject to certain income thresholds and related limitations.
Qualified Opportunity Zones: An intriguing aspect of the TCJA for real estate developers and investors is the creation of “Qualified Opportunity Zones”. Investment in these economically distressed areas, through Qualified Opportunity Funds, could defer and even eliminate capital gains on such investments.
Bonus Depreciation: The TCJA also includes expanded Section 179 and first-year bonus depreciation. Section 179 allows businesses to deduct the cost of personal property (equipment, vehicles, etc.) used for the business in the year of purchase. For 2018, the maximum deduction is $1 million, doubling the prior maximum deduction. Bonus depreciation allows a business to deduct a substantial portion of the cost of personal property used for the business in the year of purchase. Under the TCJA, the bonus depreciation amount is 100%, up from 50% previously allowed. This may be the ideal time to review your 2018 income, so that you can make informed purchasing decisions prior to yearend.
1031 Exchanges: The TCJA giveth and the TCJA taketh away. While 1031 exchanges on real property were retained, like-kind exchanges on personal property were repealed. What does this mean for business owners? Trade-ins of vehicles and equipment could now have significant tax implications. It is imperative to consult your tax advisor when contemplating a trade-in.
Net Operating Loss Carrybacks: The new law also eliminated Net Operating Loss carrybacks. NOLs are now deductible on a carryforward basis only, and up to 80% of taxable income. The TCJA also created an additional hurdle on the deductibility of business losses, beyond the customary basis limitations, passive loss, and at-risk rules. It also created possible limitations on the deductibility of business interest expense.
To say that many of the provisions of the TCJA are complex would be an understatement. In fact, the IRS has remained silent on many and we may be waiting some time for rulings and regulations to provide guidance and clarification. The LGA team is ready to review your tax situation, so that you can be better prepared to maximize any tax benefits, prior to December 31st. Contact Steve Gallant for more information.
Written by Tim Cammett