The Tax Cuts and Jobs Act (TCJA) has created new opportunities for tax planning, especially for real estate entrepreneurs and business owners. Below are five key changes to the tax code that are especially important to real estate brokers, agents, or investors with a focus on residential services.
1. Deduction for Qualified Business Income (QBI)The TCJA lowers corporate rates to 21% from 35%, but many in Congress also wanted sole proprietors, independent contractors and pass-through entities such as partnerships, LLCs, and S corporations to benefit from a lower rate. In its simplest form, the QBI deduction means that approximately 20% of business income received will be free from taxation, subject to certain limitations. For real estate professionals, this applies to:• Commissions earned as an agent• Income generated as a broker or owner of a brokerage• Rents received as a landlord• Fees charged as a property manager There are certain types of income that do not qualify for this treatment, but recent IRS guidance is favorable for real estate activities. For individuals with taxable income above $157,500 or married couples with taxable income over $315,000, the benefits of this deduction may be limited. Also, some states do not allow the QBI deduction to apply toward their income tax calculation. There are some limitations regarding rental income, as only actively managed properties qualify for the QBI deduction.
2. Changes to Entertainment Expenses The TCJA removes the ability for taxpayers to deduct entertainment expenses. This applies to any activity considered to be recreational or for amusement, and includes food items as part of an entertainment package. Taxpayers may still deduct 50% of personal and client meals related to their business, and may still deduct food purchases that are separate from entertainment packages.
3. Section 179 Expensing Under Section 179 of the tax code, qualified improvement property can be fully deducted in the year of purchase, with a limitation of $1 million per year, with phase outs starting at $2.5 million. The TCJA expands the definition of “qualified real property” to extend to roofs, heating, ventilation, air conditioning systems, fire protection, and security systems, along with furniture and appliances which were previously deductible under 179. Qualifying property can be used or new, and can be expensed even if used for personal reasons – as long as it is used for an active trade or business over 50% of the time.
4. Deducting Mortgage Interest The TCJA doubles the current standard deduction, which decreases the tax benefit of mortgage interest for many taxpayers. For those that will continue to itemize, the interest calculated on $750,000 in mortgage debt (including HELOCs used for home purchases or improvements) is deductible (homes purchased before 12/14/17 will still be allowed to deduct interest on loans up to $1.1 million under pre-TCJA rules). While this change is not necessarily going to result in higher taxes for homeowners, it does represent a potential change in the cost of renting vs. buying as a selling point.
5. Section 1031 “Like Kind” Exchanges Congress originally considered repealing section 1031 of the tax code, which allows real estate investors to sell an investment property and reinvest the proceeds in another property without recognizing capital gains (subject to certain rules). Fortunately for investors, section 1031 still applies to real property. However, personal property such as furniture, fixtures, equipment, and vehicles are now considered boot as part of section 1031 exchanges. Including these items in a 1031 exchange could trigger a taxable gain or loss. For more information about how these changes might affect you and your business, please contact your tax advisor.