Tax Rate Reductions
The new law provides generally lower tax rates for all individual tax filers. While this does not mean that every American will pay lower taxes under these changes, many will. The total size of the tax cut from the rate reductions equals more than $1.2 trillion over ten years.
The tax rate schedule retains seven brackets with slightly lower marginal rates of 10%, 12%, 22%, 24%, 32%, 35%, and 37%.
The final bill retains the current-law maximum rates on net capital gains (generally, 15% maximum rate but 20% for those in the highest tax bracket; 25% rate on “recapture” of depreciation from real property).
Exclusion of Gain on Sale of a Principal Residence -The final bill retains current law. A significant victory in the final bill that NAR achieved.
The Senate-passed bill would have changed the amount of time a homeowner must live in their home to qualify for the capital gains exclusion from 2 out of the past 5 years to 5 out of the past 8 years. The House bill would have made this same change as well as phased out the exclusion for taxpayers with incomes above $250,000 single/$500,000 married.
Mortgage Interest Deduction – The final bill reduces the limit on deductible mortgage debt to $750,000 for new loans taken out after 12/14/17. Current loans of up to $1 million are grandfathered and are not subject to the new $750,000 cap. Neither limit is indexed for inflation.
Homeowners may refinance mortgage debts existing on 12/14/17 up to $1 million and still deduct the interest, so long as the new loan does not exceed the amount of the mortgage being refinanced.
The final bill repeals the deduction for interest paid on home equity debt through 12/31/25. Interest is still deductible on home equity loans (or second mortgages) if the proceeds are used to substantially improve the residence.
Interest remains deductible on second homes, but subject to the $1 million / $750,000 limits. The House-passed bill would have capped the mortgage interest limit at $500,000 and eliminated the deduction for second homes.
Deduction for State and Local Taxes– The final bill allows an itemized deduction of up to $10,000 for the total of state and local property taxes and income or sales taxes. This $10,000 limit applies for both single and married filers and is not indexed for inflation.
The final bill also specifically precludes the deduction of 2018 state and local income taxes prepaid in 2017.
When House and Senate bills were first introduced, the deduction for state and local taxes would have been completely eliminated. The House and Senate passed bills would have allowed property taxes to be deducted up to $10,000. The final bill, while less beneficial than current law, represents a significant improvement over the original proposals.
Standard Deduction -The final bill provides a standard deduction of $12,000 for single individuals and $24,000 for joint returns. The new standard deduction is indexed for inflation.
By doubling the standard deduction, Congress has greatly reduced the value of the mortgage interest and property tax deductions as tax incentives for homeownership. Congressional estimates indicate that only 5-8% of filers will now be eligible to claim these deductions by itemizing, meaning there will be no tax differential between renting and owning for more than 90% of taxpayers.
Repeal of Personal Exemptions -Under the prior law, tax filers could deduct $4,150 in 2018 for the filer and his or her spouse, if any, and for each dependent. These exemptions have been repealed in the new law.
This change alone greatly mitigates (and in some cases entirely eliminates) the positive aspects of the higher standard deduction.
Mortgage Credit Certificates (MCCs) -The final bill retains current law. The House-passed legislation would have repealed MCCs.
Deduction for Medical Expenses- The final bill retains the deduction for medical expenses (including decreasing the 10% floor to 7.5% floor for 2018). The House bill would have eliminated the deduction for medical expenses.
Child Credit The final bill increases the child tax credit to $2,000 from $1,000 and keeps the age limit at 16 and younger. The income phase-out to claim the child credit was increased significantly from ($55,000 single/$110,000 married) under current law to $500,000 for all filers in the final bill.
Student Loan Interest Deduction -The final bill retains current law, allowing deductibility of student loan debt up to $2,500, subject to income phase-outs. The House bill would have eliminated the deduction for interest on student loans.
Deduction for Casualty Losses- The final bill provides a deduction only if a loss is attributable to a presidentially-declared disaster. The House bill would have eliminated the deduction for casualty losses with limited exceptions.
Moving Expenses- The final bill repeals moving expense deduction and exclusion, except for members of the Armed Forces. The House-introduced bill would have eliminated the moving expense deduction for all filers, including military.
Major Provisions Affecting Commercial Real Estate
Like-Kind Exchanges The final bill retains the current Section 1031 Like Kind Exchange rules for real property. It repeals the use of Section 1031 for personal property, such as art work, auto fleets, heavy equipment, etc.
The exclusion of real estate from the repeal of 1031 like-kind exchanges is a major victory for real estate stakeholders, who had fought hard to preserve the provision for several years, and against long odds.
Carried Interest The final bill includes the House and Senate language requiring a 3-year holding period to qualify for current-law (capital gains) treatment. Again, real estate stakeholders prevailed against long odds to preserve the incentive of capital gains treatment for carried interests in the final legislation.
Cost Recovery (Depreciation)-The final bill retains the current recovery periods for nonresidential real property (39 years), residential rental property (27.5 years) and qualified improvements (15 years). The bill also replaces separate definitions for qualified Restaurant, Leasehold, and Retail improvements with one definition of “Qualified Improvement Property.”
Qualified Private Activity Bonds -The final bill retains the deductibility of qualified private activity bonds used in constructing affordable housing, local transportation and infrastructure projects and for state and local mortgage bond programs. The House bill would have eliminated the use of private activity bonds.
Low Income Housing Tax Credit -The final bill retains current law. However, a lower corporate rate will negatively impact the value of the credits in the future, and will result in less low-income housing being developed.
Rehabilitation Credit (Historic Tax Credit)-The final bill repeals the current-law 10% credit for pre-1936 buildings, but retains the current 20% credit for certified historic structures (but modified so the credit is allowable over a 5-year period based on a ratable share (20%) each year).
The House bill would have entirely eliminated the Historic Rehabilitation Credit.
Provisions Not Included in the Final Bill:
Rental Income Subject to Self-Employment Tax
-The House-introduced bill would have subjected rental income to self-employment taxes. This provision was dropped from the House (and final) bill.
-Major Provisions Affecting Real Estate Professionals
– Deduction for Qualified Business Income- Because the new tax bill greatly decreases the tax rate for corporations (from the prior law’s 35% to just 21%), many Members of Congress believed that the business income earned by sole proprietors, such as independent contractors, as well as by pass-through businesses, such as partnerships, limited liability companies (LLCs), and S corporations, should also receive tax rate reductions. In addition to lower marginal tax rates, the final bill provides a significant up-front (above the line) deduction of 20% for business income earned by many of these businesses, but with certain conditions.
Specifically, the bill limits the 20% deduction to non-personal service businesses. Essentially, a personal service business is one involving the performance of services in the following fields:
Health, Law, Consulting, Athletics, Financial Services, Brokerage Services (not real estate), and “Any business where the main asset of the business is the reputation or skill of one or more of its employees or owners.”
It seems clear that most real estate agents and brokers will be considered in a personal service business and would thus not normally qualify for the 20% deduction.
However, NAR was able to help secure a major exception (the personal service income exception) in the final bill that will make it possible for many real estate professionals to be able to take advantage of the deduction.
This exception provides that if the business owner has taxable income of less than $157,500 (for single taxpayers) or $315,000 (for couples filing jointly), then the personal service restriction will not apply.
Above this level of income, the benefit of the 20% deduction is phased out over an income range of $50,000 for singles and an income range of $100,000 for couples.
For those with non-personal service income above these thresholds, the bill provides a second exception that may still allow a full or limited 20% deduction. This second exception (the wage and capital limit exception) places a limit on the deduction of the greater of:
50% of the W-2 wages paid by the business, or the total of 25% of the W-2 wages paid by the business plus 2.5% of the cost basis of the tangible depreciable property of the business at the end of the year.
Bottom Line: Independent contractors and pass-through business owners with personal service income, including real estate agents and brokers, with taxable income below the $157,500 or $315,000 thresholds may generally claim the full 20% deduction under the personal service income exception. Independent contractors and pass-through business owners with non-personal service income and total taxable income below these thresholds may also claim the full 20% qualified business income deduction. In addition, independent contractors (or other sole proprietors) with non-personal service incomes above these thresholds may also be able to claim a 20% deduction, but that deduction may be limited by the wage and capital limit exception.
The House and Senate started out with significantly different approaches to lowering the tax rate on qualified business income from sole proprietors and pass-through entities. The House bill featured a top rate approach while the Senate offered a deduction, which was set at 23% in the Senate bill. The House approach offered flexibility in allowing businesses with significant capital invested or wages paid. The final provision reflects a compromise between the different approaches. The provision generally follows the Senate proposal, but, at the request of the House, includes an additional factor related to the level of capital investment in the business.
The following examples (detailed in the Appendix) illustrate how these new changes would affect different real estate professionals based on how their income is earned, income they may claim from a spouse, and how their business is structured. NAR members should consult a tax professional about their own personal circumstances.
Example 1: Amy Agent, a single filer with sole income from real estate commissions
Example 2: Andy Agent, a married filer with children with income from his real estate business and W-2 income from his spouse
Example 3: Barry Broker, a single filer with income passed through his real estate LLC
Example 4: Bobbie Broker, a married filer with income passed through his real estate LLC and salary income from her spouse
Example 5: David Developer, a married filer with income from his development S corp, which also has wage employees and capital at risk
Section 179 Expensing
The final bill increases the amount of qualified property eligible for immediate expensing from $500,000 (current law) to $1 million. The phase-out limitations are increased from $2 million to $2.5 million.
The final bill expands the definition of qualified real property eligible for section 179 expensing to include any of the following improvements to nonresidential real property placed in service after the date such property was first placed in service: roofs; heating, ventilation, and air-conditioning property; fire protection and alarm systems; and security systems.
The bill also significantly increases the amount of first-year depreciation that may be claimed on passenger automobiles used in business to $10,000 for the year in which the vehicle is placed in service, $16,000 for the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period.
Denial of Deductibility of Entertainment Expenses
The final bill provides that no deduction is allowed with respect to:
An activity generally considered to be entertainment, amusement, or recreation;
Membership dues with respect to any club organized for business, pleasure, recreation or other social purpose, or
A facility or portion of a facility used in connection with the above items.
Thus, the provision repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business.
Taxpayers may still generally deduct 50 percent of the food and beverage expenses associated with operating their trade or business (e.g., meals consumed by employees on work travel).
Provisions Considered But Not Included in the Final Bill
Additional Withholding Requirements for Independent Contractors
Language in the Senate-introduced bill would have subjected Independent Contractors to an additional 5% withholding requirement. This provision was dropped from the Senate (and final) bills.
Expansion of Unrelated Business Income Tax (UBIT) for Non-Profits
The Senate introduced bill expanded UBIT treatment to include royalties derived from association licensing of trademarks or logos. This provision was dropped in the Senate (and final) bill. Additionally, tax writers considered subjecting certain exempt income (such as trade show or education revenue) to UBIT treatment these provisions were not included.