The Tax Cuts and Jobs Act (the "ACT") is considered the single most significant tax legislation since the Tax Reform Act of 1986. The 500+ page Act signed into law by President Trump on December 22, 2017, is anticipated to reform the tax code significantly both for individuals and businesses. Whether you own residential or commercial real estate, are in a partnership or part of a corporation, you will likely feel its effects sooner or later. Provided is a brief overview of the Act and how it will affect real estate owners and investors.
Tax-Deferred Exchanges. Section 1031 exchanges for real property have been preserved. Section 3303 of the bill, however, repeals 1031 exchanges for all personal property including but not limited to machinery, equipment, vehicles and aircrafts. Assets acquired and placed in service after September 27, 2017, and before January 1, 2023 will be eligible for 100% expensing.
Unfortunately, the repeal of personal property exchanges does leave some assets ineligible for deferral under Section 1031 or for immediate expensing. A few examples of these assets include:
Individual and Corporate Tax Rates. The new law provides lower tax rates for individuals while retaining seven tax brackets—10%, 12%, 22%, 24%, 32%, 35% and 37%. It is anticipated that the total size of the tax cut from the reductions will equal more than $1.2 trillion over ten years.
|2018 - 2015||Single||Married/Joint|
|10%||$0 - $9,525||$0 - $19,050|
|12%||$9,525 - $38,700||$19,050 - $77,400|
|22%||$38,700 - $82,500||$77,400 - $165,000|
|24%||$82,500 - $157,500||$165,000 - $315,000|
|32%||$157,500 - $200,000||$315,000 - $400,000|
|35%||$200,000 - $500,000||$400,000 - $600,000|
The corporate tax rate was greatly reduced—from 35% to a flat 21%. While the Senate bill provided that this rate would take effect in 2019, it is actually effective in 2018.
Deductions and Exemptions. Standard deductions have increased to $12,000 for single taxpayers and $24,000 for married taxpayers while personal exemptions have been suspended until after December 31, 2025.
Interest Expense Deduction. The net interest expense deduction is now limited to 30% of the ATI or adjusted taxable income.
Mortgage interest deduction. The deduction for primary residences or second homes is limited to interest on debt up to $750,000. This is down from the previous $1 Million.
Depreciation. Depreciation timelines remain as they were—39 years for nonresidential properties, 27.5 years for residential properties and 15 years for qualified improvement properties or QIP. QIP is any improvement made to the interior portion of a nonresidential property as long as that improvement is put into service after the property was initially put into use. QIP provisions apply to properties put into use after December 31, 2015.
If the taxpayer uses the mortgage interest deduction, then depreciation increases to 40 years for nonresidential properties and 30 years for residential properties.
Increased Bonus Depreciation. The new law allows businesses to take up to 100% depreciation on eligible property acquired or put in use after September 27, 2017 and before January 1, 2023. Eligible property includes new and used property and is defined as a tangible personal property with a recovery period of 20 years or less. Taxpayers can elect not to claim bonus depreciation for any property placed in use during the year. This is an annual election.
Depreciation recapture. Depreciation recapture remains at 25% for real property and is treated as ordinary income, not capital gains.
Carried interest. The one year holding period for assets was increased to three years to qualify for capital gains treatment.
State and local taxes, “SALT”. Under the new law, the deduction for all state and local taxes is capped at $10,000. This includes state and local income, property, sale and real estate taxes.
Estate tax. While an attempt to repeal the estate tax failed, the exemption was doubled to $11 Million dollars for single taxpayers and $22 Million for married taxpayers.
Capital gains and principal residence exclusion. The maximum rates on net capital gains remain unchanged at 15% or 20% for those in the highest income bracket.
While an attempt was made to change the number of years a taxpayer must reside in their home to qualify for the principal residence exclusion under Section 121, the number of years still remains at 2 out of the past 5 years with an exclusion of $250,000 for single taxpayers and $500,000 for married taxpayers.
Individual Alternative Minimum Tax, “AMT”. For taxable years after 2017 and before 2026, the exemption is increased to $109,400 for married taxpayers and $70,300 for all other taxpayers excluding estates and trusts. The phase out thresholds are $1 Million for married taxpayers and $500,000 for single taxpayers.
Corporate Alternative Minimum Tax, “AMT”. Corporate AMT was eliminated under the new law.
Section 179. The maximum amount deductible for property used after 2017 increased from $500,000 to $1 Million. The phase out threshold also increased from $2 Million to $2.5 Million. The Act also expanded the definition of qualifying property eligible for 179 expensing to include improvements to nonresidential property including roofs, heating, ventilation, air conditioning, fire and alarm systems and security systems.
Pass-Through Income. Taxpayers with qualified income generated by pass through entities including LLCs are eligible for a 20 percent deduction with income below $157,500 for single taxpayers and $315,000 for married taxpayers. For taxpayers above that threshold, deduction is limited to the greater of 50% of wage income OR 25% of wage income plus 2.5% of the unadjusted basis of the qualified property.
Partnerships. The new law repeals technical termination rules for taxable years beginning after 2017. This means that a partnership will continue even if more than 50% of the capital and profits interest in the partnership are sold or exchanged.
For sales or exchanges of a partnership interest after December 31, 2017, the transferee of the partnership interest must withhold 10% of the amount realized on the sale or exchange unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation.
The full impacts of the Act will likely take time to be felt by all sectors. Commercial real estate investors appear to be the primary beneficiaries of the new tax law.
As everyone’s situation is different, it is essential to discuss yours with a tax advisor who can help you plan for the new changes and maximize its benefits.