Back in December the President signed the tax reform legislation known as the Tax Cuts and Jobs Act (TCJA). While the main purpose might have been to lower corporate tax rates from 35% to 21% there were also some other big changes to tax laws that are directly affecting the real estate industry.
There were a lot of predictions on what the new tax reform would look like last year while it was still in its drafting stages like who would benefit and who would suffer. President Donald Trump assured the public that the changes would definitely lessen the tax burden on the middle class. As with all changes though there will also be a group that is going to take a hit especially when it comes to the real estate market.
Before getting into the list of things that were changed here are things that were untouched, well at least untouched for now:
- Low-Income Housing Tax Credits
- New Market Tax Credits
- Private Activity Bonds
- Stadium Financing Bond Interest Exclusions
- Gains on Personal Residence Sales Exclusions
- Proposed Special Interest Limitations for International Financial Reporting (Not Included)
- Proposed Unrelated Business Income Tax for Government Pensions (Not Included)
Now after reviewing that small list of things it comes quite obvious that TCJA has dramatically changed the tax landscape in the real estate market. A lot of the changes that were made are very complex and vague which makes it hard to see the resulting pitfalls and opportunities. It is important that all taxpayers carefully re-evaluate their strategies for future transactions to make sure they are considering these new tax aspects.
Tax changes on a scale this big for the real estate sector have not been seen since the Tax Reform Act of 1986. This years tax reform has a lot of positive changes for the housing market but it is important to note that most will expire at the end of 2025.
Top 3 TCJA Changes that Impact the Real Estate Market
- Pass-Through Entities. This allows a deduction of up to 20% of business income from a pass-through entity like partnerships, LLC’s and S-Corps along with sole proprietorship’s if the individual owns the real estate directly or through single member LLC. This deduction is available for both individual owners and trusts. This new deduction is available without any regard to the level of owner participation for the business which means passive investors are eligible for the deduction. Gains from selling a property is not considered qualified business income and will not be eligible for the 20% deduction. REIT dividends are also eligible for this deduction. A lot of real estate businesses are setup to own and lease rental property. Since the new deduction is only for qualified business income there is a lot of uncertainty on how to properly determine an activity’s status as a business or trade.
- Depreciation. Qualifying property acquired or built after September 2017 is now eligible for a 100% bonus depreciation for the year it is put in service. This now includes for the first time both new and used property. This bonus will drop by 20% each year starting in 2023 and be completely eliminated in 2027. Properties that qualify are ones with a depreciable life of 20 years or less and qualified improvement property. There is also an additional benefit for commercial property under Section 179 which allows for the expending of assets that would otherwise need to be capitalized and depreciated. This bonus depreciation along with Section 179 makes cost segregation studying more important than ever.
- Excess Business Losses. This new loss limitation rule is for those non-corporate taxpayers that has a limit of $500,000 if filing jointly and $250,000 for those filing singly to claim their business or trade losses for the year. The passive loss limitation rules are still going to apply so this excess business loss will pretty much only affect the taxpayers that qualify as “real estate professionals.”
Obviously the government did not do a very good job of creating tax simplification with the new TCJA laws dealing with the real estate market. Most experts were wrong in predicting that the new laws were going to wreak havoc on the housing market and cause a potential crash. In fact, overall the tax reform does bring about many tax benefits for homeowners and real estate professionals.