The President signed the Tax Cuts and Jobs Act (the Act) at the end of 2017. Given the Act’s complex and far-reaching nature, how can someone endeavor to understand ways in which it may affect their particular industry?
For the real estate and construction industry, the Act brings about changes in the realm of personal tax returns, as well as business tax items that require attention.
As has been well documented, personal tax brackets have changed across the board. Tables are available to determine if your bracket has changed or not; however, other changes may also influence which bracket you land in. But what about the other changes to personal taxes? One thing that did not change is the gain exclusion for the sale of a personal residence. The current law of living in the home for two out of the past five years may exclude the gain on the sale of a personal residence up to $250,000 (for a single taxpayer) or $500,000 (for a married couple filing jointly). However, there are new mortgage interest deduction limitations. If you purchase a new home after Dec. 14, 2017, you may only deduct mortgage interest for the first $750,000 of the new loan. The deduction for interest on home equity indebtedness is suspended from tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026. Homes with mortgages established before Dec. 14, 2017 are grandfathered into the $1.1 million cap. Second homes are also still included in this total, but they are subject to the loan total limitation depending on the date the loan was established. This new law currently expires in 2025.
Also starting for tax year 2018, a maximum of state and local tax deduction (this includes property taxes) is limited to $10,000. Previously, a limitation did not exist outside of itemized deduction phase-outs. It is also important to note that this new limitation does not apply to rental properties unless the property is used for personal purposes, in which case the new limitations could apply to the mortgage interest and real estate taxes that are allocated to personal use.
Starting in 2018, the Act creates a new 20 percent deduction based on qualified business income (QBI) from pass-through business income such as from a sole proprietorship, LLC treated as a sole proprietorship for tax purposes, LLC treated as a partnership for tax purposes, partnership or S corporation. The bill limits this deduction to “non-personal service businesses.” A personal service business is defined as performing in the following fields: athletics, brokerage services (not real estate), consulting, financial services, health, and law “where the main asset of the business is reputation or skill of one or more of the employees or owners.” Additionally, an exception allows the restriction not to apply if the business owner has taxable income of less than $157,500 (for a single taxpayer) or $315,000 (for a married couple filing jointly). Therefore, a real estate professional may be able to take advantage of either the full or limited 20 percent deduction. Please consult your tax professional to verify if you fall in the ranges to take advantage of this new deduction which is meant to similarly replicate the lowering of the corporate tax rate.
The new tax law allows 100 percent bonus depreciation for qualified assets placed in service after Sept. 27, 2017 and before Jan. 1, 2023. After 2022, the bonus depreciation reduces to 80 percent for assets placed in service in 2023, 60 percent in 2024, 40 percent in 2025, and 20 percent in 2026. The new bonus depreciation rules now apply to both new and used property (not purchased from a related party). Certain types of property, whether new or used, are not eligible for full expensing. Excluded from the definition of qualified property are properties that must be depreciated under ADS, real property trades or businesses (i.e., any real property development, redevelopment, constructions, reconstruction, acquisition, conversion, rental, operation, management or leasing), brokerage trade or business, trade or business of certain regulated public utilities, farming businesses of taxpayers who elect out of 30% limitation on business interest expense, and property subject to floor plan financing.
Additionally, Code Section 179 received some upgrades thanks to the Act. Specifically, the maximum Section 179 expense a taxpayer may elect in 2018 increases to $1 million, and the phase-out threshold amount increases to $2.5 million. Starting in 2018, inflation will index these amounts moving forward. Qualified real property under Section 179 expands to include improvements to nonresidential real property such as roofs, heating, ventilation and air-conditioning (HVAC) property, fire protection and alarm systems, security systems, and improvements that are not elevators or escalators, building enlargements or attributable to internal structural framework. This provides management a planning opportunity to determine the most advantageous times for future asset purchases.
The Act did not stop with changes to fixed assets. It also eliminates separate definitions of qualified leasehold improvement, qualified restaurant and qualified retail improvement property, resulting in a 15-year recovery period using the straight-line method and half-year convention for qualified improvement property in general (this is a 20-year ADS recovery period for this property). Also, the ADS recovery period for residential rental property shortens from 40 years to 30 years for property placed in service after Dec. 31, 2017.
In essence, many changes to the Tax Cuts and Jobs Acts affect the real estate and construction industry not only on the business level, but the personal level as well. There are a number of changes that provide immediate benefit in 2018—and thankfully, there still is plenty of time to complete 2018 planning and take advantage of the associated tax benefits.
Do you have questions about the Act and its effects on the real estate and construction industry? Our Real Estate and Construction Group can help. Please contact Christi Bieber at 813-288-8826 or email Christi, or contact Josie Weir at 813-288-8826 or email Josie.