Pros and Cons of the New Tax Law on Real Estate Owners

There are certain provisions of the new tax law that offer expanded tax cuts while others eliminate existing deductions.

One big plus is bonus depreciation. Under prior law, there was a 50 percent bonus depreciation for property placed in service in 2017, 40 percent for 2018, and 30 percent for 2019. Qualified property has to be new, not used.

Under the new law, there’s 100 percent bonus depreciation for property placed in service after Sept. 27, 2017, and before 2023, 80 percent for 2023, 60 percent for 2024, 40 percent for 2025 and 20 percent for 2026. The acquisition date for property purchased with a written contract is the date of the contract.

Qualified property includes property acquired by purchase. A qualified property does not include property used in a business that is not subject to the net business interest expense limitation (see below), but it does include property used in farm business. The law also adds a new category for qualified film, TV, and live theatrical production property. Taxpayers can elect a 50 percent bonus for 2017.

Section 179 expensing has also expanded to include roofs, HVAC systems, fire protection, alarm systems and security systems, with the allowable expense increased from $500,000 to $1,000,000 in 2018, and the phase-out deduction increased to $2.5 million. These rules now include tangible personal property acquired for rental properties, furniture and appliances.

 

Potential losses of prior credits include:

Interest deduction limitation: Interest is now limited to 30 percent of a business’s adjusted taxable income, with the exception of businesses with average annual gross receipts of $25 million or less. Real property businesses can opt out of the interest limitation if they elect the Alternative Depreciation System recovery period rather than MACRS (the Modified Accelerated Cost Recovery System). ADS recovery periods are 40 years for nonresidential property, 30 years for residential and 20 years for improvement property.

State and local tax and property tax deduction: The exclusion of local income and sales tax deductions is for non-corporate taxpayers. There is a $10,000 limit for deductibility of property tax which applies to individuals only.

Property placed in service: Under prior law you could deduct up to $500,000. The limit would be reduced dollar-for-dollar if $2 million in property was placed in service during year. Under the new law, you can deduct up to $1 million starting in 2018. The limit is reduced dollar-for-dollar if $2.5 million in property is placed in service during year. The new law also adds tangible property used for lodging (beds and other furniture for hotels and apartments) and an election for roofs, HVAC property, fire protection and alarm systems, and security systems for nonresidential real property placed in service after the date the real estate was first placed in service. The provisions are effective for property placed in service in 2018.

 

All things considered, the new tax law will provide significant tax savings for the majority of businesses given an overall reduction of tax rates and increased bonus and Section 179 deductions. Real estate owners should strongly consider projected revenue, tax liability and the application of accelerated depreciation to take advantage of these increased expenses on all acquisitions.

Tax Act Changes Deductibility of Mortgage Interest

Here are the changes in the rules for deducting qualified residential interest, i.e., interest on your home mortgage, under the Tax Cuts and Jobs Act (the Act).

 

Under the pre-Act rules, you could deduct interest on up to a total of $1 million of mortgage debt used to acquire your principal residence and a second home, i.e., acquisition debt. For a married taxpayer filing separately, the limit was $500,000. You could also deduct interest on home equity debt, i.e., other debt secured by the qualifying homes. Qualifying home equity debt was limited to the lesser of $100,000 ($50,000 for a married taxpayer filing separately), or the taxpayer’s equity in the home or homes (the excess of the value of the home over the acquisition debt). The funds obtained via a home equity loan did not have to be used to acquire or improve the homes. So you could use home equity debt to pay for education, travel, health care, etc.

 

Under the Act, starting in 2018, the limit on qualifying acquisition debt is reduced to $750,000 ($375,000 for a married taxpayer filing separately). However, for acquisition debt incurred before Dec. 15, 2017, the higher pre-Act limit applies. The higher pre-Act limit also applies to debt arising from refinancing pre-Dec. 15, 2017 acquisition debt, to the extent the debt resulting from the refinancing does not exceed the original debt amount. This means you can refinance up to $1 million of pre-Dec. 15, 2017 acquisition debt in the future and not be subject to the reduced limitation.

 

And, importantly, starting in 2018, there is no longer a deduction for interest on home equity debt. This applies regardless of when the home equity debt was incurred. Accordingly, if you are considering incurring home equity debt in the future, you should take this factor into consideration. And if you currently have outstanding home equity debt, be prepared to lose the interest deduction for it, starting in 2018. (You will still be able to deduct it on your 2017 tax return, filed in 2018.)

 

Lastly, both of these changes last for eight years, through 2025. In 2026, the pre-Act rules are scheduled to come back into effect. So beginning in 2026, interest on home equity loans will be deductible again, and the limit on qualifying acquisition debt will be raised back to $1 million ($500,000 for married separate filers).

 

If you would like to discuss how these changes affect your particular situation, and any planning moves you should consider in light of them, please give us a call.

Will the loss of the entertainment deduction affect your business?

Businesses—especially smaller firms—may scale back on treating clients to major league baseball games, golf outings and the like after Congress and President Donald Trump ended a tax break for such entertainment.

The tax overhaul that Trump signed Dec. 22 eliminated a 50 percent deduction for business-related expenses for “entertainment, amusement or recreation.” Suddenly, luxury boxes at stadiums and arenas—along with theater and concert tickets—will be more costly for firms that use them for clients.

Businesses that use the entertainment deduction extensively—including law, investment, accounting and lobbying firms—will have to gauge the effects on their bottom lines. Smaller businesses will be less able to absorb the cost.

The loss of the entertainment deduction is a kind of counterpoint to the Republican Congress’s sweeping tax cuts for businesses. The overhaul slashed the corporate rate to 21 percent from 35 percent. It also created a new 20 percent deduction for many partnerships, limited liability companies, sole proprietorships and other “pass-through” businesses, whose owners pay individual tax rates on the income they earn.

Each company will have to decide for itself whether the higher after-tax cost of these expenses makes good business sense.

Taking advantage of the new tax law to reduce taxes

 

The new tax law will affect everybody. Many individuals and companies will have opportunities to make planning decisions that could potentially reduce taxes.

Here’s an example:

For instance, let’s say you have an S Corp that has $500,000 of net income before any compensation to you, the 100% owner. Before the new tax act (Prior to tax year 2018) it would be best to pay yourself a reasonable salary and let the rest of the income flow to the bottom line. Being that both are taxable to you the salary  and the net income to you as S Corp income.

With the new tax law, the scenario will change and look more like this:

Using the example above.  You could pay yourself a reasonable $200,000 salary and let the $300,000 fall to the bottom line as net income. The new tax law states you would receive a 20% deduction on your personal tax return, or $60,000.  But wait! The House Committee reports suggest that you add back any owner compensation in computing the “Qualified Business Income” to the bottom line net income. The Senate version was silent on this. If the House version is interpreted by the IRS as the Act’s intent, the QBI would be the entire $500,000, giving you a deduction of $100,000 on your form 1040.

We will keep a close watch on this as IRS regulations and interpretations as they begin coming out, and will keep you updated. Don’t hesitate to call us anytime to discuss.

Lesson 1.02 – Jane gets a big sale

Lesson 1.01 -Jane starts a business

Major tax changes expected under Trump Administration

First New Tax Legislation in a Generation

With the new tax bill ready to be signed into law by the President, we wanted to give you a recap of the major provisions.

The final bill still leans heavily toward tax cuts for corporations and business owners. But it also expands or restores some tax benefits for individuals relative to the earlier bills passed by the House and Senate.

The individual provisions will expire by the end of 2025, but most of the corporate provisions would be permanent.

Below you will find the key provisions:

      

For Individuals

 

Many individuals will experience lower tax rates in 2018. See table to the left which will show the decrease for many tax brackets and the fact that there will still be seven tax brackets.

 

 

Nearly doubles the standard deduction:

For single filers, the bill increases it to $12,000 from $6,350 currently; for married couples filing jointly it increases to $24,000 from $12,700.

The net effect: The percentage of filers who choose to itemize would drop sharply, since the only reason to do so is if your deductions exceed your standard deduction.

Eliminates personal exemptions:

Today you’re allowed to claim a $4,050 personal exemption for yourself, your spouse and each of your dependents. Doing so lowers your adjusted gross income and thus your tax burden. You will see these exemptions eliminated in 2018.

Caps state and local tax deduction:

The final Bill limits the combined deduction for state/local and real estate taxes to $10,000. Currently taxpayers who aren’t subject to the Alternative Minimum Tax (AMT) can deduct these expenses as itemized deductions.

What to do:

If you are not subject to AMT ensure that you pay all of you 2017 state and real estate taxes in 2017.

Expands child tax credit:

The credit will be doubled to $2,000 for children under 17. It also will be made available to high earners because the bill would raise the income threshold under which filers may claim the full credit to $200,000 for single parents, up from $75,000 today; and to $400,000 for married couples, up from $110,000 today. Like the first $1,000 of the child tax credit, $400 of the additional $1,000 would also be refundable, meaning a low- or middle-income family will be able to have the money refunded to them if their federal income tax liability nets out at zero.

Creates temporary credit for non-child dependents: 

The bill would allow parents to take a $500 credit for each non-child dependent whom they’re supporting, such as a child 17 or older, an ailing elderly parent or an adult child with a disability.

Lowers cap on mortgage interest deduction:

If you take out a new mortgage on a first or second home you would only be allowed to deduct the interest on debt up to $750,000, down from $1 million today. Homeowners who already have a mortgage would be unaffected by the change. The bill would no longer allow a deduction for the interest on home equity loans. Currently that’s allowed on loans up to $100,000.

What to do:

If you are currently paying interest on a home equity line of credit, consider paying it down because the interest will no longer be deductible beginning in 2018.

Curbs who’s hit by AMT:

The final version keeps AMT, but reduces the number of filers who would be subject to it by raising the income exemption levels to $70,300 for singles, up from $54,300 today; and to $109,400, up from $84,500, for married couples.

Preserves smaller but popular tax breaks: 

Earlier versions of the bill had proposed repealing the deductions for medical expenses, student loan interest and classroom supplies bought with a teacher’s own money. They also would have repealed the tax-free status of tuition waivers for graduate students. The final bill, however, preserves all of these as they are under the current code. And it actually expands the medical expense deduction for 2018 and 2019.

Doubles Estate Tax Exclusion:

Currently set at $5.49 million for individuals, and $10.98 million for married couples.  The exclusion will be increased to $10 million for individuals and $20 million for married couples.

What to do:

Review your estate plan and utilize annual-exclusion gifts

Slows inflation adjustments in tax code: 

The bill would use “chained CPI” to measure inflation, which is a slower measure than is used today. The net effect is your deductions, credits and exemptions will be worth less — since the inflation adjusted dollars defining eligibility and maximum value would grow more slowly. It also would subject more of your income to higher rates in future years than would be the case under the current code.

Eliminates mandate to buy health insurance:

There would no longer be a penalty for not buying insurance. While long a goal of Republicans to get rid of it, the measure also would help offset the cost of the tax bill. It is estimated to save money because it would reduce how much the federal government spends on insurance subsidies and Medicaid. The Congressional Budget Office expects fewer consumers who qualify for subsidies will enroll on the Obamacare exchanges, and fewer people who are eligible for Medicaid will seek coverage and learn they can sign up for the program. But policy experts also note that the mandate repeal could raise premiums because more healthy people might decide to skip buying insurance.

For Businesses and Corporations

Lowers tax burden on pass-through businesses:

The tax burden on owners, partners and shareholders of S-corporations, LLC’s and partnerships — who pay their share of the business’ taxes through their individual tax returns — would be lowered by a 20% deduction, somewhat less than the 23% called for in the Senate-passed bill. The 20% deduction would be prohibited for anyone in a service business — unless their taxable income is less than $315,000 if married ($157,500 if single).

What to do:

Consult with your tax advisor to see if your current form of business makes the most sense going forward. This is something that a lot of businesses should study beginning in 2018. Nothing to do in 2017.

Includes a rule to prevent abuse of the pass-through tax break:

If the owner or partner in a pass-through also draws a salary from the business, that money would be subject to ordinary income tax rates. But to prevent people from re-characterizing their wage income as business profits to get the benefit of the pass-through deduction, the bill would place limits on how much income would qualify for the deduction. Tax experts nevertheless have warned that this kind of anti-abuse measure still presents taxpayers with a lot of opportunities to game the system, and favors passive owners of a business over active owners who actually run things.

Substantial cuts to corporate tax rates:

The bill cuts the corporate rate to 21% from 35%, starting next year. That’s somewhat higher than the 20% called for earlier. The bill would also repeal the alternative minimum tax on corporations.

Change how U.S. multinationals are taxed:

Today U.S. companies owe Uncle Sam tax on all their profits, regardless of where the income is earned. They’re allowed to defer paying U.S. tax on their foreign profits until they bring the money home. Many argue that this “worldwide” tax system puts American businesses at a disadvantage. That’s because most foreign competitors come from countries with territorial tax systems, meaning they don’t owe tax to their own governments on income they make offshore.

179 Depreciation limits doubled:

For property placed in service beginning after December 31, 2017, the maximum amount a taxpayer may expense under code section 179 is increased from $500,000 to $1 million.

Temporary 100% Cost Recovery of Qualifying Business Assets

 

Currently known as Bonus Depreciation, a 100% (currently 50%) first-year deduction for the adjusted basis is allowed for qualified property acquired and placed into service after September 27, 2017, and before Jan 1, 2023. The additional first-year depreciation deduction is allowed for new and used property (previously only applied to new property).

If you are not sure if this will effect your taxes, the best advice we can give you is to contact us. Whether you email Susan Hopkins at susan@marshalljones.com or schedule an appointment with Kristen Hughes 404-231-2001, we would be happy to discuss your individual situation.

IRS Issues 2018 Work Plan for Tax Exempt Organizations

The Tax Exempt and Government Entities (TE/GE) division of the IRS recently issued its FY 2018 Work Plan, which builds upon the agency’s ongoing mission to refine, realign and improve their education and examination methods. In 2017, the agency implemented data analytics and knowledge management strategies to target organizations with a high likelihood of noncompliance, and the 2018 plan continues this practice. Facing budget cuts and a declining workforce, the agency reiterated its mission, first stated in last year’s work plan, of transparency, efficiency and effectiveness.

For nonprofits preparing for 2018 now is the ideal time to review the work plan and develop a plan in the case of an IRS audit.

Fiscal Year 2018 Initiatives 
For fiscal year 2018, the IRS has outlined the following compliance strategies:

  • Examine entities that state they are supporting organizations and filed the Form 990-N
  • Examine organizations that have operated as for-profit entities in the past, but now operate as 501 (c)(3) organizations
  • Examine organizations that show signs of providing private benefit or inurement to individuals or private entities though contracts with individuals or other arrangements such as partnership agreements

If any of these attributes apply to your organization, it is crucial to ensure your financial information is organized and correct, to prepare for the possibility of an audit.

Tax Gap Issues in the Spotlight
In 2016 and 2017, the agency identified the tax gap as a key issue area. In 2016, the IRS conducted almost 5,000 examinations, with a large portion of these examinations encompassing tax gap issues, such as employment tax and unrelated business income tax. For 2018, these tax areas remain an area of concern. Organizations should be aware of the following:

  • Unrelated Business Income: Organizations should review materials as they relate to gaming, non-member income, expense allocations, net operating losses, rental activity, advertising, debt financed property rentals and investment income.
  • Employment Tax Issues: Including unreported compensation, accountable plans, worker reclassifications, noncompliance with FICA, FUTA and backup withholding requirements. In recent years, the agency has demonstrated their seriousness in pursuing these issues and leveraged the knowledge and expertise of specialists from the Federal State and Local government function. This partnership improved their ability to detect and resolve employment tax issues. As part of the FY 2018 plan, the employment tax specialists will now work as part of the same unit as the exempt organization specialists.

Due to the prevalence of tax gap issues, the agency plans to release an issue snapshot addressing the unrelated business income tax. A knowledge management product on employment tax issues is also planned to be released to help both IRS examiner and organizations get up to speed on these key issues.

Filing a form incorrectly, or making a reporting error, will not necessarily result in an audit or examination. The agency will continue to use compliance checks to determine whether an organization is keeping proper records and reporting the required information. Compliance checks allow an organization to revise filed information and tax returns, but they are not an examination or audit. With the tax gap being a major issue for many nonprofits, the first step in resolving many tax gap problems will be a compliance check.

Data and Guidance Initiatives
In May 2017, TE/GE brought online a Compliance Planning & Classification unit, streamlining processes and providing a comprehensive approach to identify and monitor compliance risks using data analytics. The agency will continue to implement data gathered from form 990, 990-EZ and 990-PF. Utilizing data analytics for increased efficiency will continue, as in FY 2018, the agency will launch a Compliance Strategy Tool and an Internal Submission Portal. These tools will facilitate crowdsourcing on areas of non-compliance. With a data-driven approach, agents will become faster and more efficient in their auditing process.

The IRS has focused on providing online guidance and knowledge materials with the expectation that this will improve compliance and increase the number of correctly submitted documents. Not only will this guidance aid organizations in the proper process for exemption filing, but it will also act as a training resource for agents, allowing for the quick resolution of issues.

Best Practices for Organizations
With the IRS work plan released, organizations can start preparing for the year ahead. If there are any uncertain tax positions, it is best to sort them out sooner rather than later. Preparation is key.

After analyzing what to expect for the coming year and identifying any potential issues, organizations should ensure they have properly documented all financial activity. A routine audit means 3-years of documentation will be examined. However, in certain circumstances, documents from years prior may be requested. For example, if an organization is offsetting current income with a loss generated two decades ago, the IRS can request information from the year of the loss. In the event your organization must challenge an IRS outcome, documentation will be crucial. Without proper documentation, it will be difficult to make a strong case.

If you need help with the application, understanding, or have further questions regarding this standard, please call 404-231-2001, ask for Nathan, or email nathan@marshalljones.com