The new tax law promises to have a significant impact on homeowners, investors, and the real estate industry as a whole. Let’s explore some of the most notable changes to real estate taxation that takes effect this year:
The home mortgage interest deduction
If you acquired new home mortgage interest debt on or after December 15, 2017, your home mortgage interest deduction will be limited to $750,000 (reduced from $1,000,000). There is no longer a deduction allowed for home equity lines of credit (HELOCs) as of January 1, 2018, but you may still deduct interest on second (vacation) home mortgage debt.
State and local tax deductions
The new limit on state and local tax (SALT) deductions to $10,000 per year will adversely affect homeowners in states with particularly high state income tax and property values, including California, and we expect a 10-15% decrease in home prices in our state. A National Association of Realtors study predicts that housing prices throughout the United States will drop by 5-10%.
The standard deduction
The standard deduction has doubled to $12,000 (single) $24,000 (married), and many itemized deductions have been eliminated – removing, for many, the tax incentives for homeownership.
Section 199A deduction
The Section 199A, 20% deduction for pass-through entities is available to individuals who invest in real estate and real estate investment trusts (REITS). Note that there are limits to this deduction –to the greater of 50% of (1) W-2 wages paid with respect to the trade or business, or (2) the sum of 25% of the W-2 wages plus 2.5% of the unadjusted basis of the qualified trade or business’ depreciable property (buildings and other property that lose value over time, not land). This deduction also phases out for taxpayers earning more than $157,500 (single) or $315,000 (couples filing jointly).
What this means, is that if you are involved in a real estate venture where services are not conducted by employees, you might wish to consider meeting with one of our tax attorneys to review and perhaps reorganize your operations to increase your wage base and avoid the harmful phase-outs of Section 199A.
Other notable tax law changes that affect real estate
Here are a few of the other changes in the tax law that real estate investors should be aware of:
- 1031 Exchange rules. The 26 U.S. Code § 1031 like-kind exchange rules were not changed for real property, but were repealed for all property that is not held primarily for sale. This means that 1031 treatment is longer permitted for exchanges of tangible and intangible property, including collectibles, equipment, and machinery.
- Carried interest. Carried interests (defined in the tax act as “applicable partnership interests”), favored by managers of private equity firms and some real estate ventures, will continue to be taxed as capital gains rather than at higher ordinary income tax rates. However, investors now have a holding period of three years instead of one. Since three years is a typical holding period for carried interests, this change appears to be more symbolic than impactful.
- Rehabilitation of historical buildings. If you rehabilitate historical buildings, you can keep your 20% tax credit but must claim it over a period of five years.
The final version of the new tax law made no change to the home sales tax exclusion. Under 26 U.S. Code § 121, exclusion of gain from the sale of a principal residence remains at up to $250,000 (single), $500,000 (married filing jointly), with the same requirement of having to live in the property for two out of the last five years.
California real estate and tax attorneys
The real estate and tax attorneys at Moskowitz, LLP are ready to review your real estate investments and devise a strategy that considers all the multiple and complex requirements of the new tax law. Contact our San Francisco office today for a consultation.