Based on the landmark new tax law, you can plan your tax strategies now—or pay the price later
By David Tobenkin
Late last year, Congress enacted landmark federal tax legislation that could bring significant tax benefits to many real estate agents and brokers, but only if they take action to understand and react to the new law.
RRC tax experts say that diving deep into the new law and addressing issues head on could help agents and brokers save big dollars on their personal taxes, better prepare them to respond to basic client questions about the law and its implications, and increase their ability to understand key new financial dynamics that will help drive transactions in their local real estate markets.
The Tax Cuts and Jobs Act of 2017 (TCJA) was signed into law on Dec. 22, 2017, with most provisions taking effect on Jan. 1, 2018. There are a few blockbuster changes wrought by the legislation and a number of additional significant ones, notes Fayetteville, Arkansas-based REALTOR® Dale Carlton, CRS, JD, a former RRC president and co-author of the new RRC course, Tax Strategies for the Real Estate Professional. Carlton says that agents and brokers need to act now to ensure they qualify for maximum benefits under the law.
“Tears will be shed by agents and brokers who didn’t quickly respond and do the right thing now and instead waited until they filed their taxes next year to worry about it,” Carlton says. “They may, for instance, have characterized income received in the current tax year in a way that will reduce the deductions they can claim next year.”
There Are Lower Tax Brackets
Most individuals should see their taxes decrease from 2017 to 2018 under the TCJA, Carlton says. That in part reflects the law’s reduction of tax rates for many tax brackets, as can be seen in the following chart:
Lower Tax Rates for 2019
| Previous rate | New TCJA rate | Change |
| 10 percent | 10 percent | No Change |
| 15 percent | 12 percent | -3 percent |
| 25 percent | 22 percent | -3 percent |
| 28 percent | 24 percent | -4 percent |
| 33 percent | 32 percent | -1 percent |
| 35 percent | 35 percent | No change |
| 39.6 percent | 37 percent | -2.6 percent |
The TCJA also increased income cutoffs that determine when someone falls into the next-higher tax bracket, which will increase the amount of income taxed at lower-rate brackets, Carlton says. Someone with taxable income of $150,000, for example, would be taxed in the 24 percent bracket under the TCJA in 2018 instead of the 28 percent bracket that was in effect in 2017. However, the TCJA is a complex law and it is possible that its elimination of some previously available exemptions, as discussed below, could result in some individuals’ taxes going up, says Evan Liddiard, CPA, senior policy representative for federal taxation, at the National Association of REALTORS®.
And a Gift for REALTORS® (A novel deduction for making money)
Beyond those tax bracket and rate changes, probably the most significant TCJA change for agents and brokers is the addition of a new deduction for sole proprietors and owners of pass-through businesses such as S corporations, partnerships and limited liability companies (LLCs)—the Qualified Business Income Deduction (QBID). Using the QBID, these business owners may be eligible to deduct 20 percent of their qualified business income if their taxable income is under $157,500 for single filers and $315,000 for married couples filing a joint return. And if taxable incomes are above those threshold amounts of $157,500 and $315,000, then the 20% QBID deduction is still available, but there is a wage and asset limitation that comes into play. The limitation is the greater of 50 percent of wages paid or 25 percent of wages paid plus 2.5 percent of the unadjusted cost basis of certain qualified assets. These rules complicate the deduction calculation; however, the net result is that taxpayers with taxable incomes above the $157,500 and $315,000 income thresholds can still claim the QBID deduction.
The QBID is a radical departure from existing IRS deductions. Many agents and brokers may fail to claim this deduction because it is counterintuitive—deductions are almost always taken based upon expenditures rather than based on net earnings, as is the QBID—and because agents and brokers were nearly excluded from the QBID deduction in early drafts of the legislation, says Chris Bird, EA, CFP, an Urbana, Illinois-based former IRS senior agent who trains accountants and real estate professionals on tax compliance. Bird is co-authoring and presenting the RRC tax course with Carlton.
This has allowed Bird, an RRC Certified Instructor, to assume the happy role of Santa Claus in his seminars: “Brokers and agents find out to their surprise that they qualify for the QBID in the first 15 minutes of the class and they get very excited,” Bird says.
BUT … You Will Need More Careful Accounting and Record-Keeping
To take advantage of the QBID, real estate agents need to make sure they account for income that qualifies for the deduction as it comes in and then report it properly in their 2018 tax returns, Bird says. It is easy for agents and brokers to overlook income that may be deductible under the QBID. For example, real estate agents often have a great deal of capital involved in the ownership of rental properties that can increase their QBID. It is Bird’s opinion that REALTORS® who own rental properties, and the more the better, will qualify to take the 20 percent QBID deduction on their Schedule E Form 1040 net rental profits, and will be able to use the original depreciable cost of the property in computing the deduction.
The challenges of negotiating the QBID alone, even aside from other TCJA provisions, may require even tax-savvy real estate professionals who have prepared their own taxes in the past to retain an accountant, which may mark a major change in the tax strategies of many brokers and agents. This is particularly the case given the IRS has yet to provide taxpayers with a document to help explain how they can best interpret and respond to the complex provisions of the law, Bird says. The complexities of the law will also increase the importance of good tax record keeping as accountants will require that information to render good advice. “Salespeople are notoriously poor record-keepers, which is why we are frequently audited,” Carlton says.
Or, the Smart Move May Be to Just Use the Standard Deduction
The new standard deduction increased from $6,350 in 2017 to $12,000 in 2018 for a single filer under the new tax law, and from $12,700 to $24,000 for filers who are married and filing jointly. The tax law changes will reduce the number of filed tax returns claiming itemized deductions from about 31 percent down to 10–12 percent, based on an NAR estimate. But whether it makes sense to itemize or use the standard deduction is another area that may require the assistance of an accountant.
Generally, there are only four deductions that remain deductible on the Itemized Deduction Schedule and will thus determine whether a taxpayer will claim the standard deduction or choose to itemize, Bird says:
• Medical expenses, if they exceed 7.5 percent of adjustable gross income.
• State and local income taxes and real estate taxes on a principal residence and one second home (all three limited to $10,000 total).
• Mortgage interest deductions.
• Charitable contributions.
The U.S. Department of the Treasury and Internal Revenue Service (IRS) issued proposed regulations on Aug. 8, 2018, implementing a significant provision of the Tax Cuts and Jobs Act, which allows owners of sole proprietorships, partnerships, limited liability companies and S corporations to deduct 20 percent of their qualified business income. Visit treasury.gov for more information.
The Bad News? Changes to Real Estate-Related Deductions May Affect Sales
Two of these four deductions are real-estate related. The mortgage interest deduction was reduced from $1 million of deductible mortgage debt down to $750,000, effective for mortgages issued Dec. 15, 2017, or later.
In addition, under the TCJA, a maximum itemized deduction of $10,000 in state and local property taxes and income or sales taxes is allowed, compared to an unlimited amount in 2017, which will limit the deduction for agents and homeowners in states with high real property tax and state income tax. Not all states have state income tax, so it may have a lesser impact on taxpayers in states with no income taxes, which include Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming, Carlton says. Some of these states do have sales taxes that will continue to be deductible up to the $10,000 total state and local cap, Liddiard says.
So is the TCJA likely to be good or bad news for sales activity? The answer is that it may depend. The impact of the TCJA upon sales may vary by market, with negative sales implications for pricier coastal regions and high-income areas, Carlton says. On the other hand, lower tax bills generally could help stimulate sales in many markets, particularly in lower-income markets. Other provisions that may affect sales activity and that agents and brokers may wish to discuss with clients are reviewed in the accompanying story located on the previous page, How to Discuss the TCJA with Clients.
But Wait, There Is More: Check Out the Change In Rules for Cars and Entertainment
Two more TCJA tax law changes are worth noting. First, the TCJA significantly limits the deductibility of entertainment expenses after 2017, which will make it important to determine what might be deductible as business promotion or advertising versus what might be regarded as entertainment. For example, when an agent hosts a reception for clients and provides food, is it 50 percent deductible as a business meal or non-deductible as entertainment? There is a relative lack of clarity in the TCJA regarding the line between the two, which makes it another area where consulting an accountant would be advisable, Bird says.
Second, a TCJA provision also significantly affects vehicle depreciation, another area of particular interest to agents and brokers. The TCJA significantly increases the 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 in the second year, $9,600 for the third year, and $5,760 for the fourth and later years in the recovery period, notes the NAR analysis. “This may influence those who once took mileage deductions or leased vehicles to instead take a depreciation of their vehicle,” Carlton says.
Carlton and Bird’s seminar will be held just prior to the NAR annual meeting and convention in Boston on Oct. 31, 2018, Halloween day. “We promise it will not be scary,” Carlton says. There will be additional presentations of the course throughout the year.
How to Discuss (or not) the TCJA with Clients
Agents and brokers will need to walk a fine line in discussing the Tax Cuts and Jobs Act of 2017 (TCJA) with clients, says Dale Carlton, CRS, JD, former RRC president and co-author of the new RRC course, Tax Strategies for the Real Estate Professional. Generally, agents and brokers should be conversant enough on the tax law to alert buyers and sellers about potential issues to consider, but they should not try to counsel them on compliance with, or application of, the law itself, a task best left for accountants. “You might want to say, ‘I am aware of a tax law consideration that might affect the advisability of this transaction that you may wish to discuss with a tax professional,’” Carlton says.
Carlton says real estate professionals also may wish to start amassing articles on taxation subjects authored by reputable tax professionals, such as tax attorneys. The National Association of REALTORS®, for example, has issued a detailed primer on the law and its implications, The Tax Cuts and Jobs Act—What it Means for Homeowners and Real Estate Professionals.
In addition to the state and local taxes and mortgage interest deduction implications, there are at least three other real estate-related changes in the law that are worth mentioning to clients:
1. INTEREST AND PROPERTY DEDUCTIONS
Generally, interest and real property tax deductions will be a less important incentive for home ownership, given that a significantly smaller number of buyers will choose to itemize versus take the standard deduction. Thus, agents and brokers should not tout the tax benefits of home ownership to current renters, Carlton says.
2. MOVING EXPENSES
The TCJA removes the ability to deduct any moving expenses except by members of the Armed Forces. Also, this change will result in an employee who is reimbursed by his or her employer for moving expenses having to pay taxes on the reimbursement. In destination markets that rely on out-of-town buyers, this could negatively impact sales activities, Carlton says.
3. HOME EQUITY INTEREST
The new law also repeals the deduction for interest paid on home equity debt through Dec. 31, 2025, though interest is still deductible on home equity loans (or second mortgages) if the proceeds are used to substantially improve the residence, according to a NAR analysis.
