The recently signed tax law will have far-reaching consequences. In fact, it is likely going to take some time before knowing the full economic effect. Nonetheless, we would like to discuss the tax law’s changes and its impact on individual and investor taxes.
Capital gainsCapital gains
Congress kept in place most of the favorable treatment. This comes about despite discussions and speculation that it was going to change.
For real estate investors, you can still defer the tax due via a 1031 tax exchange. There may be some confusion since real property retains this provision while disallowing it for other assets.
The law also retained the ability to exclude up to a $250,000 ($500,000 for those married filing jointly) capital gain from taxation. This applies only if it is your primary residence and you have lived there for at least two out of the past five years. The exemption is an important consideration for those that purchased New York City real estate in the past few years, given the sharp recovery. It is also useful for those contemplating a purchase to keep it in mind.
The long-term capital gains tax rates remain the same. These are 0%, 15%, and 20%. The 3.8% Net Investment Income Tax, which was part of the funding for the Affordable Care Act, also remains in place. This is applicable for those with a modified adjusted gross income of $250,000 (married filing jointly) or $200,000 for single filers.
Local considerationsLocal considerations
You can deduct mortgage interest for loans up to $750,000, down from $1 million. This is particularly relevant for the high cost of living in places such as New York City. However, Congress grandfathered the new law, and it is applicable only to mortgages taken out after mid-December 2017. Those with existing mortgages can still deduct mortgage interest for amounts up to $1 million. However, fewer people will be able to take advantage since you are less likely to itemize your deductions. This is because the law places a $10,000 deduction limit on state and local taxes (income and property) and the nearly doubling of the standard deduction.
The new law also eliminates the tax deductibility for home equity loan interest. Previously, you could deduct the interest on up to a $100,000 home equity loan. This is applicable to existing loans. Therefore, if you took out a home equity loan, it has become more expensive.
Commercial considerationsCommercial considerations
Real estate investors should benefit from the new law. Moreover, unlike the individual tax provisions, these do not expire. Pass-through entities, including limited liability companies (LLCs) that are commonly used by real estate investors, provide a 20% income deduction.
While the previous change received a lot of publicity, there are other benefits bestowed on real estate investors. The carried interest provision remains in place, although there is now a three-year holding period attached. This allows owners of assets, including real estate, to have income taxed at the more favorable capital gains rate rather than the higher ordinary income tax rate. Typically, the venture utilizes the LLC structure. Under this structure, the general partners, who make the operating decisions, receive a lower taxation rate. For instance, the GP may receive a higher percentage of the investment profits than his/her contribution. The taxation on the additional amount is at the more favorable capital gains rate.
Estate taxEstate tax
You do not have to worry about an estate tax unless it is worth more than $11.2 million, double the previous $5.6 million. The amount is inflation-indexed, too. This is for individuals and doubles for couples based on some planning. Without a change, it reverts back to the original amounts in 2025, however.
There is no change to the step-up basis at death, allowing heirs to minimize the capital gains tax. If they sell, they pay a capital gains tax based on the amount the inherited asset was worth, not the original cost.
Final thoughtsFinal thoughts
Taxes are a complex subject, but the new law adds another layer of uncertainty, particularly for investors. It is worthwhile to keep up-to-date, including readings from the IRS.