Tax reform may take a bite out of the average home and condominium owner’s wallet, but there still are plenty of perks left for savvy commercial real estate investors.
“Investors generally perceive the new tax law as favorable, with many showing interest in the newly created 20% pass-through deduction,” said Hessam Nadji, CEO of Marcus & Millichap, commercial real estate specialists. “This represents a unique opportunity for investors to reconsider their portfolios in order to ensure they fully capitalize on new tax laws and maximize return on equity.”
However, Evanston-based tax consultant Tom Swigert of Thomas Swigert & Associates, says the 2018 Tax Cuts and Jobs Act is not as beneficial to the average American as experts say.
“Congress set up all the rules for real estate to provide tax benefits for landlords so Americans would have access to good, cheap housing,” Swigert noted. “However, tax reform gives landlords the idea that they can only get tax benefits by raising rents so they can generate more profits.” Congress wasn’t thinking of this concept when drafting the 2018 tax bill, Swigert believes.
“One result of reform will be that Americans will see more expensive housing costs,” Swigert said. “What if professional sports franchises go out of business when corporations stop buying blocs of season tickets? And, who knows how many restaurants will close from lack of business?”
According to Marcus & Millichap, here are some of the positives that wealthy commercial apartment owners and other investors are counting on to put big bucks in their pockets:
• Mortgage interest. While the new tax law reduces the average homeowner’s mortgage-interest deduction cap to $750,000 from $1-million, real estate investors will be able to deduct mortgage interest on their commercial properties in full. Another perk for the big investor-owners is their net income will only be taxed at a 21% federal rate, down from 35% under former law.
• Cost recovery. Commercial real estate owners now are allowed to take a full, 100% property-cost deduction in the same year in which their assets were acquired. Currently, owners can deduct 50% of a qualified property’s cost in the first year, then continuing depreciation in the years following.
• Pass-through taxation. Entities organized as “pass-through,” such as partnerships and limited-liability companies, will pay a top individual federal tax rate of 37%. Additionally, the pass-through business income will be eligible for a 20% deduction. Combined, these provisions could lead to a top federal tax rate of 29.6% on business income, well below the current 39.6%.
It’s important to point out that the 20% eligibility applies to business owners with incomes higher than $157,500 (for single filers) or $315,000 (for couples filing jointly), Marcus & Millichap noted.
However, local tax consultant Swigert said the 20% deduction starts out with a little twist.
“Uncle Sam gives the investors a 20% deductions off their business profit (from corporations, partnerships, and Schedule C—off businesses, farms, rentals, REITs and more), or 20% of their taxable income, whichever is less,” Swigert noted.
Here’s an example. Let’s assume apartment rentals bring in a $100,000 profit, so the 20% deduction of profit is $20,000. However, if that is the investor’s only income, the $100,000 profit gets reduced by the 2018 Standard Deduction of $24,000. So, the tax deduction is only $15,200.
For non-math experts, that’s $100,000 minus $24,000 equals $76,000. And 20% of $76,000 is $15,200. “Because the investor gets the smaller of the two, the 2018 tax deduction is only $15,200,” Swigert explained.
• Historic preservation tax credit. Developers wanting to renovate older structures can breathe a sigh of relief, according to Marcus & Millichap. The 20% tax credit for certified historic structures is still in place, with the provision that it’s claimed over a five-year period. However, the 10% tax credit for rehab of non-certified structures built before 1936 is eliminated.
• Like-kind exchanges. Real estate investors and residential owners who were relying on the 1031 Exchange to defer capital gains taxes also will be happy. Tax reform did not tinker with this important benefit.
While commercial real estate investors and owners likely will benefit under the new law, the story is somewhat different on the residential side for the average homeowner. Marcus & Millichap outlined the following negatives:
• Deduction issues. Tax reform almost doubles the standard deduction for single filers to $12,000 from $6,350, and married couples to $24,000 from $12,000. This is a great move for filers who don’t itemize their deductions.
However, experts say it could be catastrophic for single-family homeowners, especially if their standard deductions are higher than the mortgage interest they pay on their homes.
The National Association of Realtors (NAR) pointed out that doubling the deduction really means reducing mortgage interest and property-tax deductions. These deductions are key incentives for home ownership and help preserve the fabled “American Dream.”
“Congressional estimates indicate that only 5% to 8% of filers will now be eligible to claim these deductions by itemizing, meaning there will be no tax differential between renting and owning for more than 90% of taxpayers,” the NAR analysts said.
And, while the new plan still allows interest deductions of up to $1 million on existing mortgage debt, interest deductions on new mortgages are capped at $750,000.
Thankfully, the Internal Revenue Service recently has ruled that home-equity loan interest deductions are still allowed providing the money is used improve the property.
Another concern is tax reform’s elimination of state and local income tax (SALT) and property-tax deductions. The impact will be felt among single-family home, co-op and condo owners, especially in urban cores and high-tax states, such as Illinois, experts predicted.
For more housing news, visit www.dondebat.biz. Don DeBat is co-author of “Escaping Condo Jail,” the ultimate survival guide for condominium living. Visit www.escapingcondojail.com.