The Tax Cut and Jobs Act of 2018 has made some rather large changes to the tax law that will certainly impact a majority of investment property owners. Here’s our review of those changes along with some opinion on if it’s good or bad for the investor. You should always consult with your financial advisors and tax consultants before using the information presented here. They are the experts in this area.
Overall Commentary: Trying to be politically neutral here as we really don’t want to get into politics on this site. This is about investments and investing, buying, selling, and running your business. Please keep your comments limited to the law itself, not to the political swirl around the law.
In general, we believe these changes will create jobs. On the surface, and by CBO accounts, taxes are lowered in the United States as a result of this Act. Somewhere in the area of $1.5 trillion (with a “T”) over the next ten years. Whenever people have extra money they tend to spend it. Why are there so many advertisements around refund time? Because businesses know that people use their tax refunds to buy things. That’s also a reason why we like our property investments available in the Spring. Potential residents have the cash from their refunds available.
Specifically, we really think the modifications to Sec 179 of the tax code will do a lot to help revitalize investment properties that have gone into disrepair. Honestly, it’s pretty hard to do $10,000 roof replacement when you know it will not take $10,000 off your income for the year it was replaced. For the next five years, many of these expenses are immediately deductible so at least you’ll be lowering the income you make on the investment right away.
We also think the 20% business income deduction, available for flow-through entities like LLCs, will hold the lid on rental increases and/or be a job creator. Again, the investor will have more money in their pockets and the tendency is to spend that money. Either on new properties, improvements to their properties, or by keeping their rents lowered. The downside to this is it might heat up the rental markets and put more pressure on multifamily markets. We also think it’s going to hurt (yes hurt) the house buyer, especially first-time house buyers. The lower-priced housing typically bought by the first-time buyer is going to be pressured by investment-property buyers.
First, the highlights of changes:
Bonus Depreciation has dramatically changed:
Many improvements made after 9/27/17 and through 12/31/2022 become immediately expensable. After that, bonus depreciation on your investment starts to phase out. We really like this change and think it’s a job creator. Roofing, window replacement, and contractors (if they were smart) would start advertising this and should be really busy over the next five years. Now there were a lot of nuances to the changes made in section 179 so make sure you’ve consulted with your CPA. If you were thinking about making improvements to your properties, the next five years is the time to do it.
Changes to HELOC and Interest deductions on personal homes
HELOC interest in no longer tax deductible unless used for investment properties and interest deductions on primary and second homes is limited to the first $750K of debt. If you do take out a primary home loan and use the proceeds to buy investment properties, you can still deduct the interest against your rental income. Get your CPA involved here! We’re OK with this change.
Interest expenses within a business are expenses that business incurs, so using a HELOC to pay for them means you can deduct the investment interest. The challenge you’ll have is tracking everything. You want to make sure you do this correctly to prevent an audit or miss out on the tax deduction you should claim. In general, we don’t like mixing business with personal so make sure you’ve got everything in order before using this strategy.
Entertainment and Business Meals
A lot of change to this one. Under the new law, business-related meals are only 50% deductible and entertainment expense deductions are eliminated. This change, we feel, is a job killer, especially for soft businesses like restaurants. I can see the pharmaceutical industry screaming about this one. Expense accounts will be cut which means business lunches will be curtailed. Employee parties will be cut back. So the services industry is going to be hit hard with this one.
The 1031 Exchange Remains for Investment Real Estate
For most other types of tangible property, it’s eliminated. This change will impact certain niche investors but not do too much to the real estate investor. We like the 1031 Exchange provision. It keeps money moving in the economy and provides avenues for expanding your investment portfolio without huge tax consequences. We wish, though, that they would have taken a look at the draconian timelines and rules around performing a 1031 Exchange. Way too limiting in our opinion.
Tax Bracket Changes versus Capital Gains
No change to the long-term capital gain rates in the bill. This means holding your property as an investment instead of flipping it might make your taxes low when you sell it for a gain. Some individual investors, especially new investors with smaller active income, might actually pay more in taxes by holding for the long term. But we think this is going to be a rare case. If you flip properties, that money becomes active income and that extra income will likely bump you into a higher tax bracket. Again, consult with your tax advisor to see which is better for you.
Tax preparation fees are no longer deductible
We disliked this provision before and despise it even more right now. How many times have we already mentioned consulting with your tax advisor? Well, tax prep fees can’t be deducted any more… expect they can for the rental income portion. Tax prep fees are deductible against rental income so you should make sure a portion of your tax prep fees (that used for the rental property portion of your taxes) is still deducted from your income.
Why do we despise this law? First, because the complicated tax code means most people will require someone else to do their tax preparation for them. Second, because larger corporations get to deduct a lot of their tax prep fees by using in-house accountants and paying them salaries, which are deductible. We just feel this provision should apply to every tax payer, not just those who can afford their own in-house accounting. Yes, we can still allocate a certain percentage of tax prep fees against the business. But we’d like everyone to be able to take advantage of this, including the individual taxpayer.
The “Death-Tax” Exemption has Doubled
The new law exempts the first $11M for single and $22M for married couples from the “death-tax”. This tax, more than just about any other, is a political hot-potato. For real estate investors, this is a big deal. Modest portfolios over 110 doors, at $50K per door, were previously subjected to this tax for the single person investor and as such often meant selling a portion of the portfolio just to cover the taxes. If you own some side businesses, hitting the old thresholds wasn’t too hard to do. Which often meant business were sold or went into disrepair after the death of its owners due to taxes due. This could especially hit those owning lots of land in prime areas like Edwardsville, Glen Carbon, or Shiloh. A farmer who owns several hundred acres could easily be at the old limit. The beneficiaries of the estate would have to liquidate and/or take debt against it to pay off the taxes. No honestly, this tax really only hit those who didn’t plan their estates well while they were living. So it’s really not a big deal that the limits were increased.
Individual tax brackets dropped for nearly every person, but deductions on an individual basis also changed. Many will pay less in taxes but a few will end up paying more. It’s also important to note that tax rates are only in law until the end of 2025. After that, it’s anybody’s guess. Also, a change in Congress and/or the Presidency in upcoming elections could change these provisions of the tax code. State and local tax deductions are no longer fully deductible as there is a $10,000 deduction limit. Illinois investors, who have both high personal income and property tax rates, might feel the pinch of this one. If you won a $300K primary residence in Madison County and make $100K a year, you’ll pay around $11,000 in state and local taxes. You will only be able to deduct $10,000 of that on your federal income tax. (Note, this does not apply to your income-producing assets in most cases as those are expenses to the business).
Charitable Deduction limits were raised to 60% of Adjusted Gross Income, but this will only apply in rare circumstances.
Medical and Dental expense deduction thresholds were increased.
Itemized deduction limitations were repealed. But the standard deduction was also increased. In either case, you’ll probably get a higher deduction.
Family Tax Credits were doubled with $1,400 of it being refundable. There is a phase out now for those about $400K, married and filing jointly.
In general, we believe the changes made will impact both the economy and job markets. To what extent remains to be seen. The federal government will certainly see less income in the near future as a result of these changes, so that may impact it’s ability to provide services in the future. Those accepting housing vouchers like Section 8 may be challenged as budgets might be cut.
This law will also put some pressure on the rental housing market. Demand will increase if you’re able to actually make money on rentals. As we all know, it’s getting harder and harder these days to make money on a rental, so the additional money provided by these changes could bring in new investors. Of course, local actions like inspections, business licenses for each unit, etc. continue to put downward pressure on our rental profitability so how much of a difference this will make remains to be seen. But we do think we’ll see prices rise as long as financing costs stay low.
Looking forward to your comments! Keep them clean. We know there’s a lot of people for and against this new law but try to keep your thoughts centered around how it will impact the rental business.
Some great articles used to write this post are:
To Your Investing Success!