2017 Tax Law Overview
The tax bill has come to a rest for signature of the President with most changes becoming effective in 2018. For budgetary purposes, the period of which the law is changed ends in 2026. I believe this is the ten year window for deficit control over major revenue changes.
The outline below highlights some of what we consider to be the more significant tax changes.
I. Tax Rate Changes. There are rate reductions in all brackets. There will be total tax saving of $32,000 on the first $1m of taxable income for married filers. Top marginal tax rate is lowered from 39.6% to 37%. Top corporate tax rate is reduced from 35% to 21%.
II. Capital Expenditure Write Off. Bonus depreciation has been supercharged:
1. Bonus depreciation now allows for immediate expensing of qualified property through 2022 with the percentage phasing down thereafter. In a major shift in policy, used property is now eligible for this immediate write-off. Previous law allowed 50% bonus depreciation and only on new property. This will be a major benefit to parties that actively acquire qualified property. Cost segregation analysis will yield an immediate write off for cost basis allocated to onsite land improvements and personal property. Refurbishment costs performed post-closing to the interior of a building will also be qualified property for this write off. This applies to assets acquired after September 27, 2017.
2. Enhanced automobile depreciation.
III. Exclusion for Business Income. There is a deduction for noncorporate taxpayers of up to 20% of qualified business income. This deduction is limited to the smaller of 1) taxable income, 2) aggregated business income from pass through entity or 3) portion of the taxpayers prorata share of wages paid to employees and 2.5% of the cost basis of assets used in the trade or business. This is a freebie but not as great as it seems after limitations are applied.
IV. Business Interest Deductions. There is a new limitation on the deduction of business interest expense for pass through entities and corporations equal to 30% of EBITDA through 2021 and EBIT after 2021.
1. The law, as drafted, allows Real Estate professionals to elect out of the interest limit by electing into longer depreciation lives on assets without sacrificing Bonus depreciation. The election into a longer depreciation life amounts to foregoing the 27.5 and 39 year life for residential and commercial, respectively, and using 30 and 40 in its place. For most real estate professionals, retaining an unlimited interest deduction combined with Bonus depreciation will be better planning.
2. The interest deduction limit is applied separately for each pass through entity.
3. Excess Interest is carried over to future years.
V. Business Loss Limit. An aggregation of business losses that exceed $500,000 per year is disallowed and such excess is carried over to future years as a Net Operating Loss. This is a cap on allowing business losses to offset other nonbusiness sources of income.
VI. Like Kind Exchange. 1031 exchange is retained for real estate.
VII. Disallowed Deductions. The following changes which effect itemized deductions:
1. Itemized deduction of State and local income tax is capped at $10,000.
2. No more miscellaneous itemized deduction.
3. No more itemized deduction phase out for high income taxpayers.
VIII.Net Operating Losses. Changes include the following:
1. Cannot be carried back two years anymore
2. Carryforward in perpetuity.
3. Limit use of NOL’s in carryforward years to 80% of taxable income before the NOL deduction.
IX. Carried Interest. Capital gains are taxed as ordinary income for promoted ownership positions held less than 3 years.
X. Estate lifetime exclusion. This has been increased to $11.2M in 2018 for individuals and $22.4M for couples.
XI. Home Sale. The gain exclusion of 250,000 for single filers and $500,000 for married filers remains unchanged in the final law.
As can be seen, there is a mixture of favorable and unfavorable changes that counteract one another to varying degrees depending upon circumstances. The changes necessitate intricate calculations and elections to understand how the tax bill will affect your pocket book. These calculations necessitate looking through to the raw data of all pass through entities and rolling up information to the taxpayer level. Without compiling the minutiae, it is difficult to precisely conclude whether the law changes will be to your benefit or detriment. In 2018, we expect more extensive information reporting by each pass through entity to its owner for the ultimate taxpayer to accurately apply deduction enhancements and limitations.
For many real estate professionals that are actively deploying capital we expect the enhanced Bonus depreciation combined with 1031 gain deferral opportunities and electing out of the interest limitation will be an improvement over prior law.
More guidance will need to be published by the IRS to clarify and coordinate the new law and how it interfaces with existing law.
Most of our clients will be paying their property tax and state income taxes before the end of this year 2017. Let’s talk about your personal situation, business structure and the elections that may be necessary for planning in the new year.