The National Association of REALTORS® (NAR) worked throughout the tax reform process to preserve the existing tax benefits of homeownership and real estate investment, as well to ensure as many real estate professionals as possible would benefit from proposed tax cuts. Many of the changes reflected in the final bill were the result of the engagement of NAR and its members, not only in the last three months, but over several years.
Introduction
While NAR remains concerned that the overall structure of the final bill diminishes the tax benefits of homeownership and will cause adverse impacts in some markets, the advocacy of NAR members, as well as consumers, helped NAR to gain some important improvements throughout the legislative process. The final legislation will benefit many homeowners, homebuyers, real estate investors, and NAR members as a result.
The final bill includes some big successes. NAR efforts helped save the exclusion for capital gains on the sale of a home and preserved the like-kind exchange for real property. Many agents and brokers who earn income as independent contractors or from pass-through businesses will see a significant deduction on that business income.
As a result of the changes made throughout the legislative process, NAR is now projecting slower growth in home prices of 1-3% in 2018 as low inventories continue to spur price gains. However, some local markets, particularly in high cost, higher tax areas, will likely see price declines as a result of the legislation’s new restrictions on mortgage interest and state and local taxes.
The following is a summary of provisions of interest to NAR and its members. NAR will be providing ongoing updates and guidance to members in the coming weeks, as well as working with Congress and the Administration to address additional concerns through future legislation and rulemaking. Lawmakers have already signaled a desire to fine tune elements of The Tax Cuts and Jobs Act as well as address additional tax provisions not included in this legislation in 2018, and REALTORS® will need to continue to be engaged in the process.
The examples provided are for illustrative purposes and based on a preliminary reading of the final legislation as of December 20, 2017. Individuals should consult a tax professional about their own personal situation.
All individual provisions are generally effective after December 31, 2017 for the 2018 tax filing year and expire on December 31, 2025 unless otherwise noted. The provisions do not affect tax filings for 2017 unless noted.
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[1]) 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[2].
- For those with non-personal service incomeabove 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 her 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 but these provisions were not included.
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