This blog post was originally published on February 7, 2018. It was updated on November 7, 2018.
You could miss out on some benefits of tax reform if you wait too long
The Tax Cuts and Jobs Act includes a number of provisions affecting the real estate industry, generally in positive ways. But year-end tax planning with your advisors is more essential than ever.
Most urgent: Maximize the new deduction for qualified business income (QBI).
The new tax law includes a QBI deduction break for owners of certain pass-through entities. Pass-through entities include subchapter S corporations, partnerships and some limited liability companies. This may reduce your maximum effective tax rate for 2018.
Owners of some pass-through entities will now receive a 20% deduction on qualified business income, effectively reducing their maximum effective tax rate from 39.6% in 2017 to 29.6% in 2018. The deduction may be limited to 50% of the W-2 wages paid, or the sum of 25% of the wages plus 2.5% of depreciable basis. There’s another plus for pass-throughs: they keep the deduction on entity-level state and local taxes.
The QBI deduction limitations and restrictions are set at the owner level. Planning for year-end 2018 should include discussion of salaries, timing and distribution of income.
Expanded limits on excess interest could be avoided.
The new law expands existing limits on interest deductibility to all businesses, including real estate partnerships. It caps the deduction of interest to interest income plus 30% of EBITA, limiting the excess interest that many businesses traditionally deducted.
This might be a non-issue for some real estate businesses who elect to use the alternative depreciation system (ADS). The new tax law retains the 15-year recovery period for qualified improvement property, and the existing 40-year alternative depreciation system for non-residential real property. The good news is a new 30-year ADS period for residential property and a 20-year ADS period for qualified property improvement.
Electing ADS is a strategy to consider and to discuss with your tax advisor, to help you deal with the new limitations on excess interest deductibility.
You could benefit even more from bonus depreciation and cost segregation.
Bonus depreciation is a method of accelerated depreciation, allowing you to take an additional deduction the first year you own qualified property. Under the new tax law, the rules have changed in two ways: the portion that can be depreciated and the types of property that qualify.
Previously, bonus depreciation was calculated at 50% of the basis of qualified property, and only new property qualified. For property acquired after September 27, 2017, and through the end of 2022, 100% of the basis can be depreciated. And the property can be “used,” as long as it’s new to the taxpayer. Both changes provide notable advantages to real estate businesses.
In addition, developers, buyers and owners of commercial real estate often overlook the benefits of a cost segregation study because of the perception that the study will simply result in a timing difference in how a building is depreciated. However, an engineering-based cost segregation analysis can lead to significant tax deferrals, a boost in cash flow and an increase in capital immediately available for new projects. Cost segregation will look at all the costs associated with the construction or purchase of a commercial real estate property or a residential rental property.
Ask your tax advisor about properties you think may qualify for bonus depreciation or cost segregation.
Opportunity zones could present a tax-advantaged investment strategy.
The new opportunity zone program gives investors in certain economically distressed communities the opportunity to defer tax capital gains. You can create funds to seed new businesses, provide capital in order to expand existing businesses or invest in real estate development. There are 67 opportunity zones in Miami-Dade county alone, and 427 in the State of Florida. Opportunity zones can offer tax benefits for real estate developers, investors and investment funds. The longer you hold the property, the greater the benefit. If you defer your gains on opportunity zone investments for 10 years, you’ll pay no tax on the appreciation of your investment.
In addition to fulfilling the promise of providing investment dollars to distressed communities, tax advantaged investments in opportunity zones may be beneficial for you or your clients.
Contact your tax advisor to learn more about these and other provisions within the new tax law that could affect you or your business.