The Tax Cuts and Jobs Act of 2017 has many temporary effects on homeowners and real estate investors.
So what do they need to consider as we head into tax season? Tracy Green, a Planning and Life Events Specialist for Wells Fargo Advisors, explains five key real estate–related provisions that could potentially impact your tax bill for tax years 2018 through 2025.
1. Lower limits on deductions for home mortgage and home equity loan interest
For any new mortgage or home equity debt taken after December 15, 2017, taxpayers who itemize can only deduct interest on the first $750,000. And, Green says, the interest is only deductible “if it’s used to buy, build, or improve your primary residence or one second home.”
If the acquisition debt was incurred on or before December 15, 2017, the loan amount eligible for deductible interest remains the same as before—up to $1 million.
Key action to consider: If you’ve taken out (or are thinking about) a new home mortgage or home equity line of credit, consult a tax advisor on how that could affect your tax bill.
2. New restrictions on using home equity debt interest
This is another big change: Interest from home equity debt is now deductible only if it’s used to buy, build, or improve the property the debt is secured by and falls within the appropriate limits. Green notes that, previously, taxpayers would use home equity lines of credit to pay off other debts or fund a child’s education—this interest is no longer deductible. Other homeowners would take out a home equity line on their personal residence to purchase or improve a vacation home.
“Under the new rules, this would no longer be allowed. The home equity debt would have to be secured by the vacation home itself in order to be deductible,” she says.
Key action to consider: If you have a home equity line or second mortgage, talk to your tax advisor now to avoid surprises on April 15.
3. Changes to state and local tax (SALT) deductions
In addition to limits on home interest deductions, the tax law sets a $10,000 limit on SALT deductions for individuals not businesses.
That said, tax reform also raised the standard deduction to $12,000 for single taxpayers and $24,000 for married couples who file jointly for 2018. With the increased standard deduction and the new limits on mortgage interest and SALT deductions, many taxpayers will find themselves taking the standard deduction instead of itemizing.
Key action to consider: Consult your tax advisor to see if it’s worth itemizing your 2018 tax returns.
4. Changes to how REIT income is taxed
Investors may be able to deduct up to 20% of their real estate investment trust (REIT) income using the “qualified business income” deduction under the new tax law. REIT income is generally taxed as ordinary income so this effectively reduces the tax rate. For some investors, this may mean holding a REIT in a tax-advantaged retirement account might not be as important.
“If you’re looking to create an income stream in your taxable account, REITs may be a good idea,” Green says.
Key action to consider: If you own or are considering purchasing REITs, talk to your financial advisor about your objectives and evaluate whether they should be held in a taxable or tax-deferred account.
5. New rules for rental property income
There’s a new 20% deduction for pass-through businesses that could apply to some—but not all—taxpayers who earn money from rental properties.
The IRS hasn’t finalized the Section 199A regulations yet, Green says, but preliminary information suggests the 20% deduction will only be allowed for income from a “trade or business.”
For rental property owners, Green says this may come down to a “facts and circumstances” test that will assess whether or not the property owner is really engaged in a trade or business (rather than simply owning rental property).
Several factors, including what operational tasks the property owner does and how much time they spend on the business, will be important. “It’s going to be open to interpretation until they give us more details,” Green says.
Key action to consider: If you own rental property and it’s not your primary business, work with your tax advisor to determine if or how you may be able to take advantage of this new deduction.