The proposed tax reform hit the internet last week. Though there are likely to be many changes and revisions, in its current form, there are many impacts to those who invest in real estate. Let’s explore these.
Changes in Deductions
The proposed tax reform has changed, reduced, and eliminated many deductions for the American taxpayer. Several of these changes will affect real estate investors. These include:
- $10,000 deduction cap for state and local property taxes
- Mortgage interest deductions will be limited to loans under $500,000 rather than $1 million
- Eliminate interest deductions for second homes
Capital Gains
Taxation of Business Entities
Most investors have formed an LLC in which to do business. This next section deals with changes to business entity taxation that could affect your company.
- A 3-year holding requirement for carry or promote services to get long-term capital gain tax rates
- Foreign investors, even those investing in LLCs, will be obligated to pay federal, state, and local income taxes
Benefits
However, the changes to the code are not all bad news. Here are some ways that real estate investors will benefit:
- Maximum 25 percent pass-through business income rate
- Only 30 percent of business income is subject to the 25 percent rate. The rest of the income is subject to regular income tax rates, which are also being revised
- Repeal of the estate tax beginning in 2023 and reducing it in the meantime
What This Means as an Investor
If the proposed tax reform passes as it stands, there will be many homeownership tax benefits no longer available to the American public. Without these benefits, many Americans may decide not to own a home. Because of this, owning rental properties and multi-family properties may become more attractive.
However, I wouldn’t begin buying just yet. Since homeownership is a crucial piece of the American dream, it is likely that there will be opposition to the removal of these reductions.
Another thing to consider is the reduction of state and local tax deductions. This may make states with low or no income taxes, like Florida and Texas, more attractive. At the same time, states with high income taxes, like California and New York, may find themselves in a weaker market.
The point is to think about the taxation situation when buying investment properties on both the state and local level. In this new tax scenario, lower is better than ever.
Of course, with this tax reform just out, you can rest assured that this is not the final draft. Continue to watch as this tax reform makes its way through Congress so that you can capitalize on any tax changes made that affect real estate investing.
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