In late December 2017, Congress passed the Tax Reform and Jobs Act and President Trump signed it into law effective Jan. 1, 2018. Below are some commonly asked questions and answers regarding the tax reform bill and its impact.
What happened to the mortgage interest deduction?
Beginning now, the new cap for this deduction is $750,000, down from $1 million.
The mortgage interest deduction for existing mortgages of up to $1 million taken out before Dec. 15, 2017 will not be affected. Homeowners may also refinance mortgage debts existing on Dec. 14, 2017, up to $1 million and still deduct the interest, so long as the new loan does not exceed the amount of the mortgage refinanced.
What about deductions for second homes?
Deduction of interest on loans secured by a second house will still be allowed subject to the $1 million and $750,000 caps, as noted above.
Are there any changes to home equity loan deductions?
Yes. The interest on home equity loans will only be deductible if the proceeds are used to substantially improve the residence.
How much can a California homeowner deduct in state and local property taxes?
California residents now have a $10,000 combined cap on all their state and local tax deductions, inclusive of real property taxes, state or local income taxes, or sales taxes. The $10,000 limit applies to both single and married filers and is not indexed for inflation.
How are capital gains impacted?
The Tax Cuts and Jobs Act does not change the $250,000 for single filers and $500,000 for joint returns exclusions from capital gains tax for the sale of a principal residence when the homeowner has owned and lived in the home for two of the last five years.
It also retains the current long-term capital gains rate of 15 percent generally, but 20 percent on those in the highest tax bracket. Depreciation recapture for real property remains at 25 percent.
How did the federal tax brackets change?
There will continue to be seven federal tax brackets, but the marginal tax rates in each bracket will be slightly lower.
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What’s new with the standard deduction?
The standard deduction will nearly double for 2018 to $12,000 for individuals and $24,000 for joint filers. Analysis shows that by doubling the standard deduction, Congress has greatly reduced the value of the mortgage interest and property tax deductions as tax incentives for homeownership. Congressional estimates indicate that only 5-8 percent of filers will now be eligible to claim these deductions by itemizing, meaning there will not be a tax differential between renting and owning for more than 90 percent of taxpayers. This consequence is felt more keenly in California than other parts of the country due to California’s higher overall tax rate and higher home prices.
How did personal exemptions change?
Personal exemptions for taxpayers and dependents have been repealed. Under prior law, tax filers could deduct $4,150 for the filer and his or her spouse, if any, and for each dependent, but they will no longer be able to do so.
Can I still deduct qualified business expenses?
Yes, in certain instances. A provision that may be helpful to real estate licensees is the deduction for qualified business income. It will allow an off the top (above the line) deduction of 20 percent of business income, subject to certain provisions. It will be available not only to certain pass-through entities, S corporations, and Limited Liability Companies, but also for sole proprietors, such as independent contractors.
While personal service businesses, (which likely include real estate agents and brokers) were initially ineligible for the 20% deduction, the final bill has a personal service exemption. In other words, many real estate professionals will be able to take advantage of this deduction. There are income limitations of $157,500 for single taxpayers and $315,000 for joint filers. Above these income levels, phase out provisions apply.
What changes were made to Section 179 expensing?
The Act increases the amount of qualified property eligible for immediate expensing from $500,000 to $1 million. The phase-out limitations are increased from $2 million to $2.5 million.
The definition of qualified real property eligible for section 179 expensing has been expanded 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 Act 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.
May I deduct entertainment expenses?
No. There is no deduction 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;
- A facility or portion of a facility used in connection with the above items.
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).
What does the 20 percent qualified business income deduction mean for rental income?
The 20-percent deduction applies to rental income since the changes that produced the “wage and capital exception” were intended to apply to rental income. However, what exactly constitutes a qualified trade or business is not well defined by tax law. There are a number of different interpretations for different purposes of the tax code. Typically, to qualify as a business, the activity must be regular, continuous, and substantial.
How will home prices be affected?
C.A.R.’s initial analysis shows that home prices in California would decrease an average of 4.1 percent in the short term, with some price ranges dropping more than others. Approximately 1.9 percent due to the loss in tax incentives and 2.2 percent due to the inability to deduct state and local property taxes.
What impact will tax reform have on existing home sales?
C.A.R. estimates that existing home sales would decline 2.9 percent. As the tax saving incentives of being a homeowner vanish, fewer buyers will be inclined to purchase a home.
How will this affect inventory?
Inventory is already constricted in California, but it is estimated to decline an additional 1 percent as a result of tax reform. With a decline in home prices, homeowners may be reluctant to list their properties for sale. The reduction in the cap of the mortgage interest deduction, in fact, could disincentivize some current homeowners to ever move again.
Were there any changes to like-kind exchanges?
No. Tax deferred IRC section 1031 like kind exchanges for real property will be retained. Personal property 1031 exchanges are no longer allowed.
Were Mortgage Credit Certificates Retained?
Yes. The Act retains Mortgage Credit Certificates (MCCs). The MCC program is a home buyer assistance program designed to help lower-income families afford homeownership. The program allows the home buyer to claim a dollar-for-dollar tax credit for a portion of the mortgage interest paid per year, up to $2,000. The remaining mortgage interest paid may be calculated as an itemized deduction.
After an MCC is issued, the homeowner receives a tax credit equal to the product of the mortgage amount, the mortgage interest rate, and the “MCC percentage,” a rate the administering Housing Finance Agency sets between 10 and 50 percent.
How did the cost recovery low income housing tax credit change?
Although the Act retains the Low-Income Housing Tax Credit (LIHTC), it will be of less value to many investors. With the corporate income tax rate changing to 21 percent, the rate reduction will negatively impact the yield on existing LIHTC deals by reducing the value of post-2017 losses from 35 cents per dollar to 21 cents per dollar. For future deals, the reduced value of tax losses will translate into reduced pricing from equity investors, which will require project developers to incur more permanent financing and/or defer larger amounts of developer fees
Is there still a tax credit for historic structures?
The 10-percent credit for pre-1936 buildings was repealed, but the current 20-percent credit for certified historic structures was retained. However, it has been modified so the credit is allowable over a 5-year period based on a ratable share (20 percent) per year.
Can I still deduct moving expenses?
No. Moving expenses will no longer be deductible, except for those in the military.
What is the impact on the child tax credit?
The child tax credit will be increased from $1,000 to $2,000.
May I deduct for casualty losses?
No. The Tax Cuts and Jobs Act only allows casualty losses to be deducted in a presidentially declared disaster.