How the New Tax Law Affects Rental Real Estate Owners
Do you own residential or commercial rental real estate? The Tax Cuts and Jobs Act (TCJA) brings several important changes that owners of rental properties should understand. In general, rental property owners will enjoy lower ordinary income tax rates and other favorable changes to the tax brackets for 2018 through 2025. In addition, the new tax law retains the existing tax rates for long-term capital gains. (See "Close-Up on Tax Rates" in the right-hand box.) Unchanged Write-Offs Consistent with prior law, you can still deduct mortgage interest and state and local real estate taxes on rental properties. While the TCJA imposes new limitations on deducting personal residence mortgage interest and state and local taxes (including property taxes on personal residences), those limitations do not apply to rental properties, unless you also use the property for personal purposes. In that case, the new limitations could apply to mortgage interest and real estate taxes that are allocable to your personal use. In addition, you can still write off all the other standard operating expenses for rental properties. Examples include depreciation, utilities, insurance, repairs and maintenance, yard care and association fees. Possible Deduction for Pass-Through Entities For 2018 and beyond, the TCJA establishes a new deduction based on a noncorporate owner's qualified business income (QBI) from a pass-through business entity — meaning a sole proprietorship, a limited liability company (LLC) treated as a sole proprietorship for tax purposes, a partnership, an LLC treated as a partnership for tax purposes, or an S corporation. The deduction generally equals 20% of QBI, subject to restrictions that can apply at higher income levels. While it isn't entirely clear at this point, the new QBI deduction is apparently available to offset net income from a profitable rental real estate activity that you own through a pass-through entity. The unanswered question is: Does rental real estate activity count as a business for purposes of the QBI deduction? According to one definition, a real property business includes any real property rental, development, redevelopment, construction, reconstruction, acquisition, conversion, operation, management, leasing or brokerage business. Liberalized Section 179 Deduction Rules For qualifying property placed in service in tax years beginning after December 31, 2017, the TCJA increases the maximum Section 179 deduction to $1 million (up from $510,000 for tax years beginning in 2017). Sec. 179 allows you to deduct the entire cost of eligible property in the first year it is placed into service. For real estate owners, eligible property includes improvements to an interior portion of a nonresidential building if the improvements are placed in service after the date the building was placed in service. The TCJA also expands the definition of eligible property to include the expenditures for nonresidential buildings:- Roofs,
- HVAC equipment,
- Fire protection and alarm systems, and
- Security systems.
- Beds and other furniture,
- Appliances, and
- Other equipment used in the living quarters of a lodging facility, such as an apartment house, dormitory, or other facility where sleeping accommodations are provided and rented out.
- Qualified leasehold improvement property,
- Qualified restaurant property, and
- Qualified retail improvement property.
- Your aggregate business income and gains for the tax year, plus
- $250,000 or $500,000 if you are a married joint-filer.
Loss Limitation Rules in the Real World Dave is an unmarried individual who owns two strip malls. In 2018, he has $500,000 of allowable deductions and losses from the rental properties (after considering the PAL rules) and only $200,000 of gross income. So he has a $300,000 loss. He has no other business or rental activities. Dave's excess business loss for the year is $50,000 ($300,000 – the $250,000 excess business loss threshold for an unmarried taxpayer). The $50,000 excess business loss must be carried forward to Dave's 2019 tax year and treated as part of an NOL carryfoward to that year. Under the TCJA's revised NOL rules for 2018 and beyond, Dave can use the NOL carryforward to shelter up to 80% of his taxable income in the carryforward year. Important: If Dave's real estate loss is $250,000 or less, he won't have an excess business loss, and he would be unaffected by the new loss limitation rule. |
Close-Up on Tax Rates
If you own property as an individual or via a pass-through entity — meaning a sole proprietorship, a limited liability company (LLC) treated as a sole proprietorship for tax purposes, a partnership, an LLC treated as a partnership for tax purposes, or an S corporation — net income from rental properties is taxed at your personal federal income tax rates.
For 2018 through 2025, the TCJA retains seven tax rate brackets, but six of the rates are lower than before. The 2018 ordinary income rates and tax brackets are as follows:
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