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“The time to buy is when there’s blood in the streets.”
This famous quote attributed to Baron Rothschild summarizes what every dedicated real estate investor knows: Whenever a significant change occurs, there’s an opportunity to make money. The Tax Cuts and Jobs Act is no different — there are a considerable number of substantial changes, and knowing what those are and how to position yourself effectively are the keys to generating profit.
How To Save Money Under The Current Tax Law
The first and most readily apparent effect of the tax overhaul is the decrease in the corporate tax rate from 35% to 21%. If you haven’t already formed a corporation to house your investments, you need to consider doing so now. That 14% decrease will save quite a bit of money if you’re structuring your income correctly.
Congress also decreased the mortgage interest tax deduction limit from $1 million to $750,000. It isn’t uncommon for real estate investors to utilize their own home residence as a method of financing their rental properties. Rather than borrowing against your home residence now, you should borrow against the rental property itself. This will allow you to use the interest as a deduction. To do this, you’ll have to change your depreciation schedule from the current 27.5 years to 30 years. If you currently invest in high-end properties, you might want to shift your focus to real estate that’s valued a bit lower to maximize your deduction.
The rules for Section 179 tax deductions have changed as well, allowing you to deduct 100% of new and personal property. The limit has essentially doubled, from $510,000 to $1 million. The definition of “new” has also been expanded to mean “new to you,” allowing for the purchase of used assets that were previously ineligible.
The law expanded the list of qualified real estate that’s eligible for Section 179 deductions to include improvements to nonresidential property, including HVAC systems, rooves and security and fire alarm systems. If your portfolio includes commercial properties, you could potentially reap substantial tax benefits with investments in these areas.
How To Make MoneyUnder The Current Tax Law
Section 1031 tax deferment is another area that’s been significantly adjusted. The new law repeals the use of Section 1031 for property that is defined as “personal,” which includes things like auto fleets, heavy equipment and securities but retains its use for real estate. Depending on how your portfolio is structured, it might make sense to shift a number of your investments into real estate. In other words, if you’re not investing in real estate, start — and if you’re already doing it, increase your investments.
The standard deduction increase provides the impetus for arguably the greatest shift in investment strategy. By virtually eliminating itemized deductions, the new tax law shifts the benefit you can gain by owning property. In cities with high property taxes, it generally makes more sense to rent, and in areas that have low property taxes, it’s better to own. If your strategy is focused on the development of raw property into homes, pick areas where the property tax rate is low. If you prefer to be a landlord, concentrate on areas with high property taxes.
Earlier, I mentioned forming a business entity to take advantage of the decreased corporate tax rate. There’s another area where you can benefit from this: The law allows for a 20% automatic deduction of your pass-through income if you earn less than $157,000 (single) or $315,000 (married). If your income is above those levels, don’t give up yet — there are two exceptions. You can still utilize this deduction for either 50% of W-2 wages, or “the total of 25% of the W-2 pages 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.”
Keep in mind that you control how much you pay yourself as the owner of a corporation, and you should speak with an accountant or tax attorney regarding how to best incorporate this into your investment strategy. A 20% deduction is nothing to laugh at, so make sure this is something you investigate thoroughly.
Capital gains is an essential area for serious real estate investors. Congress increased the requirement to three years to qualify for capital gains treatment, with one exception: C corporations. Depending on how essential capital gains are to your investment strategy and whether you tend to hold properties for less than three years, this change might drive a serious conversation with your tax attorney.
For everything other than C corporations, this adjustment rewards longer-holding strategies and will have greater financial benefits for real estate investors who practice buy-and-hold strategies, rather than quickly building or flipping a home for an immediate profit.
In The End
Making the most of the opportunities provided by such substantial changes is critical to maximizing your long-term profitability. The Tax Cuts and Jobs Act provides a significant number of vehicles that maximize the potential value of real estate investing. Educate yourself on the changes and adapt your business model to align with new best practices: The opportunities for property investment are greater than ever.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.