The Tax Cuts and Jobs Act was signed by the President on Friday December 22, 2017. The Act makes sweeping changes to many parts of the tax law for both individuals and businesses that will have a significant impact on the real estate industry. While this alert reviews the most significant implications to the real estate industry, it should not be lost that the application of these changes to your specific facts and circumstances will be unique and should be discussed with your Elliott Davis tax advisor.
There will be seven brackets of taxable income with the top rate lowered to 37% on income over $600,000 (married filing jointly) or $500,000 (single and head-of-household). The rate changes will expire after 2025. Remaining unchanged is the net investment income tax rate of 3.8%.
Capital Gain and Dividend Rates
No change was made to reduce tax rates on capital gains or qualified dividends.
A new rule will limit businesses from deducting interest in excess of 30% of Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) (EBIT starting on January 1, 2022), with an exemption for smaller businesses that have average gross receipts of $25 million or less (over a three year period). An exemption is also allowed for debt relating to a real property trade or business. Both the gross receipts limit and real estate exemption apply at the entity level. Absent one of the exemptions, disallowed interest is carried forward indefinitely.
Real property trade or businesses that elect the interest limitation exemption must use a depreciable life of 40 years for nonresidential property (otherwise 39 years), 30 years for residential real property (otherwise 27.5 years), and 20 years for qualified improvement property (otherwise 15 years) making them ineligible for accelerated depreciation.
Bonus Depreciation/Section 179 Deduction
Tangible personal property (including used property) and land improvements that are purchased and placed in service between September 27, 2017 and December 31, 2022 are eligible for an increased bonus depreciation of 100%. Also increased is the Section 179 expense deduction to $1 million with an increased phase-out threshold of $2.5 million.
A 20% deduction is now available for qualified pass-through business income, with certain exceptions. Taxpayers with taxable income below $315,000 for married filing jointly ($157,500 for individuals) are eligible for the full deduction. When taxable income is above these thresholds, the deduction is limited to the greater of a) 50% of W-2 wages paid by the business, or b) 25% of W-2 wages plus 2.5% of the unadjusted basis (before depreciation) of depreciable property. The limit is phased in above the thresholds. When taxable income exceeds the above thresholds, qualified business income excludes income from a service business. Service business is currently defined as law, accounting, brokerage services, financial services and investment management, consulting, or any trade or business where the principal asset is the reputation or skill of one or more of its owners or employees (excluding engineering and architecture).
When a partnership interest is transferred (directly or indirectly) to a taxpayer in connection with the performance of substantial services by the taxpayer in the area of raising or returning capital, investing in specified assets, or developing specified assets, a new 3-year holding period is required to receive long-term capital gain treatment. This applies to both the sale of the partnership interest, or the underlying assets in the partnership. Among other items, a specified asset includes real estate held for rent or investment.
The tax deferred Section 1031 exchange rules were modified to now apply only to real property (not held primarily for sale). Personal property used in a trade or business, including vehicles, are no longer eligible.
Business expenses incurred for entertainment, amusement, or recreation are no longer deductible starting on January 1, 2018.
Prior rules requiring a partnership to administratively terminate for tax purposes on the date of a significant ownership change have been repealed. This repeal will subject the new continuing entity to any irrevocable elections made prior to the new owners’ purchase. Additionally, all owners (buyers and sellers) will be included on the same tax return for the transaction year.
Net losses generated from active trade or businesses can now only offset non-business income of up to $500,000, for married filing jointly ($250,000 for an individual). Any unused losses are carried forward as part of the taxpayer’s net operating loss. Additionally, any net operating loss generated after December 31, 2017 is limited to 80% of taxable income when used in a future year. The carried forward period is now indefinite.
Standard Deduction/Child and Dependent Credits
The standard deduction increased to $24,000 for married filing jointly taxpayers ($18,000 for heads of household and $12,000 for individuals). The personal exemption was eliminated, but the child tax credit was increased from $1,000 to $2,000 of which $1,400 can be refundable.
A deduction for property tax and state and local income tax was retained, but with an overall limit of $10,000. Medical expenses will continue to be deductible, but at a lower threshold of 7.5% of adjusted gross income (expiring in 2019). Qualifying debt for home mortgage interest will be limited to $750,000 for debt incurred after December 15, 2017 on a first and second homes combined. Interest on home equity loans is no longer deductible. Charitable contributions will continue to be deductible on an increased limit of 60% of adjusted gross income. However, contributions made in exchange for university athletic seating rights will no longer be deductible after December 31, 2017. All other items, including unreimbursed employee business expenses and tax preparation fees are no longer deductible.
We Can Help
If you have questions about any of the provisions in the Tax Cuts and Jobs Act, or need help in understanding how it may affect your business, please contact your Elliott Davis Tax Advisor.