The Effect of Tax Reform

On December 22, 2017, Donald Trump signed into law a 1,097 page document called  “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018,” also known as the ‘Tax Cut and Jobs Act of 2017,’  which will take effect for the taxable 2018 year. The next few pages attempt to summarize some the most impactful changes for those involved in the real estate industry.

For years, politicians and political action committees have tried to push forth changes to the US tax code, but to no avail. It has been argued that the current code is too difficult to understand with its voluminous provisions and rules, which seem dated as they do not to take into account our current economic culture, such as globalization.

Alas, a valiant effort was made to “unrig the tax code,” and on December 20, 2017, congressional Republicans struck a deal on tax reform and on December 22, 2017, President Donald Trump signed into law “the most drastic change to the US tax code in 30 years.”

The law, which was enacted at the impetus of the republicans in the house and senate, permanently slash corporate tax rates, offer temporary cuts for individuals, and repeal the individual mandate in Obamacare.

Many of those concerned about the new tax law are members of the Residential Real Estate community. The mortgage interest deduction is capped on a mortgage of $750,000 for loans taken out after December 14, 2017, as opposed to $1,000,000 which was the amount the law formally capped the mortgage interest deduction at; and taxpayers will not realize as great a savings as they once did. The mortgage interest and real estate tax deductions were significant components of the itemized deductions on taxpayers tax returns and therefore, at times, a contributing factor in deciding to cross the threshold and status from being a rental tenant to homeowner by purchasing a home.

The National Association of Realtors (NAR) is anticipating that this change alone will cause housing prices to drop by 10% across every state in the United States. The NAR likes to refer back to the Ragan administration, when in 1980, the income tax deductions were parred back, but home interest deductions were kept in place; primarily because of the belief that home ownership is part of the American dream and the mortgage interest and real estate tax deductions are important tools to assist with the costs of homeownership, therefore helping Americans attain the American dream. The Reagan administration was not interested in taking the chance of being blamed for ruining the American dream. President Trump seems to be a bit more brazen.

Proponents of the tax bill argue that by doubling the standard deduction, the mortgage interest deduction, and state and local property tax deductions are no longer needed.

It is extremely important to note that some of the individual changes to the tax code are temporary and will revert back to the prior law, in 2026.

The new 2017 law which will be effective for the 2018 taxable year contain some significant changes to the tax code, namely, a significant increase in the standard deduction; the curtailment of state and local income tax deductions; limiting the deductibility of mortgage interest; eliminating the itemized personal deduction for Home Equity debt; and a major overhaul of the corporate tax rates.

–          Individual Tax Rates:

The new law keeps seven tax brackets for individuals, but six are at lower rates. In 2026, the current-law rates and brackets will return. The temporary tax brackets under the new law are as follows:

Single Joint Head of
household
10% tax bracket  $0 – $9,525 $0 – $19,050 $0 – $13,600
Beginning of 12% bracket

$9,526

$19,051

$13,601

Beginning of 22% bracket

$38,701

$77,401

$51,801

Beginning of 24% bracket

$82,501

$165,001

$82,501

Beginning of 32% bracket

$157,501

$315,001

$157,501

Beginning of 35% bracket

$200,001

$400,001

$200,001

Beginning of 37% bracket

$500,001

$600,001

$500,001

–          Significant Increase in the standard deduction:

The standard deduction which taxpayers can opt to take has been significantly enhanced for the 2018 tax year. To put this into perspective, in 2017, the standard deductions for a single filer was $6,350, and $12,700 for joint filers. The new tax law has now raised the standard deduction for a single filer to $12,000 and $24,000 for joint filers. The standard deduction for “head of household,” an individual who is not married but has dependents, has been raised as well to $18,000. Unfortunately, you cannot have your cake and eat it too – the cost of raising the standard deduction is the removal of some itemized deductions and personal exemption.

–          Removal of the Itemized Personal Deduction:

For taxpayers who have filed itemized deductions in the past, the personal exemption has been $4,050, this exemption will no longer exist until the taxable year of 2026.

–          Limiting the deductibility of mortgage interest:

Anyone who purchased a home on or before December 14, 2017, will not be affected by this provision of new law.

A homeowner with an existing mortgage can refinance the mortgage debt up to $1 million, the same as in 2017, and still deduct the interest as long as the new loan does not exceed the old loan.

Mortgage interest on second homes purchased before December 14, 2017 can still be deducted, but is subject to the new $750,000 principal balance limit.

A home purchased after December 14, 2017, is subject to the new rule of limiting the interest deduction to mortgages of $750,000, and is only applicable to primary residences; vacation or secondary home mortgage interest will not be deductible.

There are some who suggest that to help offset the loss of the mortgage interest deduction on a secondary home; if the home is rented out, the cost associated with the home can be written off as a business deduction, which would include a portion of the mortgage interest and property taxes.

–          Home equity Line of Credit:

Prior to the enactment of the new tax law, the US tax code allowed homeowners to borrow against the equity they had built up in their property and use the proceeds for whatever purposes the taxpayer chose. Taxpayers had been able to include the interest payments in their itemized deductions, with a cap of $1.1 million combined between the first mortgage and HELOC/second mortgage. The new tax law has eliminated the itemized tax deduction for home equity debt. Even if someone has an existing Home Equity Line of Credit, 2017 is the last year the interest can be written off.

But all is not lost! A carve out in the final language of the new tax law states that if the funds from the HELOC or second mortgage combined with the t first PM mortgage does not exceed $750,000, and said funds are used for renovations or other home improvements, the interest are deductible.

In the taxable year of 2026, interest payments for HELOC’s in the amount of $100,000 or less will deductible regardless of the use of the proceeds.

–          Curtailment of state and local income tax breaks:

The new tax law limits the local property tax deduction (SALT) to $10,000. In states such as New York and California where property taxes are high, homeowners will feel an additional burden by not being able to subsidize and  justify the payment of high real estate taxes as being worthwhile because of its inclusion as an itemized tax deduction.

This too will revert back to the old law for the 2026 tax year.

–          Capital Gains Exclusion when selling a home:

Taxpayers will continue to be able to exclude up to $500,000 (for a couple) or $250,000 (for single filers) of capital gains tax when they sell their home.  However, as is presently the case, the taxpayer must have lived there for 2 out of the previous 5 years.

–          Corporate and Business Tax Impact:

The main component of the new tax law in regard to corporate and business taxation deals with a change to the tax structure for entities known as pass-through entities. Pass- through entities account for about 95% of US businesses. Sole proprietorships, Limited Liability Companies, Partnerships, and S Corporations are all examples of pass through entities.

The new tax law provides a 20% deduction for “qualified business income,” defined as income from a trade or business conducted within the US, by a Limited Liability Company, Partnership, S Corporation, or Sole Proprietorship. The 20% deduction will lower the amount of the business’s taxable income. The goal of this deduction is to give pass through entities some financial breathing room to allow business owners to reinvest that saved money back into the business. This deduction is allowed against business profits and does not apply to wages earned by the business owner.

However, there are caveats to this deduction. “Service-type” businesses, such as accounting and law firms, are excluded from this deduction. The lawmakers’ intent was to prevent solo law practitioners and accounting firms to benefit from the tax break because of the belief that the relief from the deduction will not in those cases be reinvested into the business. The tax deduction is meant to provide a break on a portion of the business’s income that results from capital income. Capital income are generally items from assets, as opposed to labor income, which is income generated from human labor and should therefore be left out.

Another caveat is that the deduction begins to phase out for joint return filers earning $315,000, and $157,500 for individual filers.

The information provided above is a brief synopsis and summary of some of the provisions listed in the “Tax Cut and Jobs Act of 2017.” You should not rely on this article, but rather contact your tax professional with any questions you may have. This article is intended to provide an awareness of the issues involved.

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