Some of you may have heard that congress passed a new tax act which became law on December 22nd, 2017 called the Tax Cuts and Jobs Act of 2017. There are several controversial components of the law, but since the debate is legally over how will it affect real estate investment?
First of all, I’m not a tax accountant, lawyer, or licensed professional of any sort. I make my living by investing in real estate, so I’m personally interested in the results of my examination, but my interpretation is by no means final. If I pique your interest with anything here please go read the relevant sections yourself, or better yet, hire a professional tax consultant to work through your situation with you (You can read it here: congress.gov, or get the wikipedia summary here: Wikipedia summary).
Here were the parts that stood out to me from a real estate investment perspective, I’ll talk about them one at a time:
Number one will mostly affect homes that are acquired as primary residences or seconds homes that are purchased for about $1,000,000 or more. What they’re doing is reducing the amount of debt that can be tax deductible to $750,000. Since debt like that can be pretty easily used to get a house around $1,000,000 that’s about the cutoff, and after that an owner will need to pay an interest rate effectively higher by the amount of their marginal tax bracket. This won’t have much effect on real estate investors because very few investors are buying such expensive homes as investment homes and trying to treat them for tax purposes as qualified residences.
Number two is really unfortunate for homeowners. It means that mortgage interest on any cash-out loan is not deductible, raising the effective interest rate on cash-out loans by the borrower’s marginal tax rate. For example, if you’ve paid off the original mortgage on your $100,000 house and want to get some of that equity back out and your marginal tax rate is 25% then an 8% loan now looks like a 10% loan to you because of the extra that you’ll pay in taxes if you take out that loan in 2018 versus 2017. Sorry pal. This will make it harder for people to get started in real estate investment, because for most of them their own home probably will be their first investment and the asset they’ll want to use to leverage into more investments via loans against the equity they develop.
Number three means that property tax (and other state, local, & sales tax) deductions for individuals will be capped at $10,000. This will affect real estate investors with personal residences in the range of $350,000+ assessed value depending on the tax rate for their county. All of the property, sales, state, & local taxes that are paid in excess of that will be effectively more expensive with the new law by the marginal tax rate of the taxpayer. For people with nice homes that they like living in, they’ll probably just pay some more taxes and live with it. But if a real estate investor owns multiple properties in their own name, and if they didn’t have enough reasons already, they should seriously think about getting those properties into legally separate entities. Otherwise the increase to their taxes could be considerable.
Number four is actually an aid to most real estate investors. The predominant form of legal structure for real estate investment is the LLC, which is a form of pass-through entity that would benefit from this deduction. The deduction can be as much as 20% of the income from the business reducing the federal tax burden also by about 20%. This is effectively a large tax cut that should help real estate investors with good legal structures and skilled tax counsel hold on to more of their money.
The tax law affects a lot more than just real estate, so look at some other sources. I hope that helps give you some ideas of what you should be aware of with regards to property ownership though. Until next week!