The new tax law ( 2017 TCJA) is great news for the commercial real estate industry. Owners of pass-through entities may deduct up to 20 percent of their business income on their tax return, subject to certain limits, and increased deductions for capital expenditures will shield income for property owners who make capital investments and improvements in properties.
The new pass-through deduction will benefit real estate owners holding title through partnerships, LLCs, and S-Corps generating qualified business income. Rental properties with net income after amortization and depreciation will receive a 20 percent deduction on net income or a 2.5 percent deduction on your property’s unadjusted basis. The pass-through provision is quite complex, but there are huge potential savings available to real estate investors, who carefully plan for these opportunities.
For example, imagine your client owns several rental properties, one of which was purchased many years ago for 2 million dollars and is fully-depreciated, but now worth $20 million. If that property is producing $1 million net income from rent, the 199A deduction is limited by the qualified property limitation (2.5% of the unadjusted basis) to $50,000. If that same client also owns another property, which was recently purchased for $10,000,000 and rents for $1 million per year, that property is not eligible for the section 199A deduction because the depreciation and interest deductions will offset all of its rental income. However, if your client borrows against the older property and pays off the loan for the new property with the proceeds, the second property is then eligible for $200,000 section 199A deduction. The total section 199A has grown from $50,000 to $250,000!
TCJA will allow many real estate investors to fully expense qualified new and used property, with a recovery period of 20 years or less, acquired after Sept. 27, 2017. This is a major tax benefit for the real estate industry and may favorably impact returns to investors. Under the previous tax rules, the bonus depreciation deduction was limited to 50% of the eligible new property. The new tax law allows bonus depreciation and immediate deduction of 100% of eligible property placed-in-service after September 27, 2017, and before January 1, 2023. Eligible property is expanded to include used property, reduced by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2.5 million. These amounts are indexed for inflation for taxable years beginning after 2018.
The new tax law expands the definition of section 179 property to include certain depreciable tangible personal property improvements made to the nonresidential real property, such as roofs, HVAC, fire protection, alarm systems and security systems as long as the improvements are placed in service after the date the building was first placed in service.
Also, the deductible amount that can be expensed has doubled, from $500 thousand to $1 million. This is great news for commercial and short-term rental owners. Non-residential properties can take advantage of Section 179 for fire systems, security systems, roofs, and HVACs. When 100% first-year bonus depreciation isn’t available, the Sec. 179 tax deduction provides similar benefits.
A 1031 Exchange, which has been part of the tax law for almost 100 years, allows real estate investors to defer tax when the property is exchanged for “like-kind” property The tax is deferred until the last “like-kind” property is sold. The good news is that commercial real estate investors can still take advantage of the 1031 exchanges rules under the new tax law.
Moskowitz LLP is a tax law firm with over 30 years of experience. We pride ourselves on providing realistic and practical solutions. Moskowitz LLP reminds taxpayers that the tax code can cost or save you money, depending on how you use it. The 2017 Tax Cut and Jobs Act provides commercial real estate sector new and increased opportunities to put the tax code to work for you.