The end of 2017 ushered in a new tax reform act, and it has some benefits and maybe some disadvantages as well. So what should real estate investors know, specifically? According to Anderson Advisors, being prepared regarding tax planning is essential for real estate investors. Otherwise, they risk paying higher tax rates than they need to.
The following are some of the top things for real estate investors to know about changes in the tax laws this year.
Mortgage Interest Deductions
People living in more expensive states like New York and California are the ones who might have seen more detrimental changes in their taxes because of new legislation.
Starting in 2018, the mortgage interest deduction is capped at $750,000 of debt. That means property owners with a primary residence can deduct interest on only up to $750,000 of their debt. This applies to loans taken out after December 14, 2017.
For current loans of up to $1 million, they’re grandfathered and not subject to this limitation.
For secondary residences, the cap is the same with mortgage deduction limits set at $750,000.
Also, prior to 2018, you could itemize your property, income and sales tax, but now that’s limited to $10,000.
Depreciation Recovery Period
While mortgage interest deductions apply to homeowners, things related to depreciation recovery periods are primarily aimed at investors.
The depreciation recovery periods haven’t changed, so for residential rentals as an example, this is 27 ½ years.
The law increased bonus depreciation from 50% to 100% for assets with what is called useful lives of less than 20 years. This means if you’re buying personal property for your rentals or you’re making land improvements such as adding new parking or landscaping, you can write off the entire cost of those things immediately.
However, you can’t write off the cost of purchasing an actual rental property, because they have useful lives of 27 ½ years, which was touched on briefly above. It also is worth reiterating that this refers only to bonus depreciation. If you’re an investor and you sell those assets, you’ll be responsible for paying depreciation recapture tax.
Bonus depreciation retroactively began in September 2017. For people who made improvements or purchases at the end of 2017, they can be written off completely.
Before the new legislation, net income from rents was taxed at 39.6 percent, and for passive investors, there was a 3.8 percent tax for the Affordable Care Act. That was a total of 43.4 for passive investors and just under 40 percent for active investors.
Under the new bill, investors who qualify for the newly added 20 percent deduction will see their net rental income is taxed at 29.6 percent plus for passive investors, the 3.8 percent for the ACA.
Finally, for an investor to qualify for the full deduction of 20 percent, the business either has to pay a certain amount of wages, or they need to have a specific investment in depreciable, tangible property. This wouldn’t include things like inventory or land property.