Under the 2018 tax code, real estate rentals are looking good. Unfortunately, it’s not looking so good for home owners. Here’s a look at how the tax code looks for real estate investing in 2018.
Effects of the Pass-Through Loophole on Single-Family Home Availability and Ownership
The main catalyst of so many of the indicators seen here is a pass-through income deduction, designed to benefit those business owners who create jobs. Under the new code, instead of paying a regular income tax rate, which might be as much as 37 percent, a landlord can now simply create a limited-liability corporation (LLC) on the property and pay the pass-through rate of 27 percent (this percentage has various stipulations for taxpayers with incomes above certain thresholds). This means that landlords might be incentivized to hold on to properties longer rather than selling them.
This is but one of the hits that real estate professionals and potential homeowners took from the legislation. As many real estate investors know, one of the main hurdles facing the housing market in 2017 was lack of inventory. This loophole makes renting single-family homes attractive.
Another contingency is that this will drive construction to focus on apartments rather than single-family dwellings. If there was one bright spot last year, it was an increase in new homes to sell. That increase may end if investors find it more lucrative to build apartment buildings.
The lower pass-through rate also applies to anything that is leased and produces income. Premium apartment buildings owned by corporations, real estate investment trusts, and other large investors aren’t eligible for the credit, as they don’t pass profit directly to income. Smaller, privately-owned office buildings, however, are eligible, and those structures are often built away from cities, which may mean another hurdle to the construction of single-family homes.
Effects of Doubling the Standard on Home Ownership
The effect of the (essentially) doubled standard deduction also has the potential to dampen new home ownership. Moody’s Analytics estimates that as many as 38,000,000 Americans might choose the higher deduction when they would otherwise itemize. The doubled standard interest deduction essentially removes a tax incentive for home ownership, which means that fewer Americans will choose to buy for the tax advantages alone.This spells opportunity for landlords.
Effects of the Plan on Rental Properties
All of the pieces together show potentially great gains for anyone who has anything to do with rental property. Real estate investors who deal in rentals could have a good year. Wealthy real estate investors can make a bundle building smaller apartment complexes, turning them into LLCs, and taking the pass-through tax credit.
Other Items of Note
- The elimination of the Domestic Production Activity Deduction (DPAD) will have a negative effect on flippers, developers, and builders.
- The Section 121 Exclusion, sometimes referred to as the $250,000 or $500,000 exclusion, stayed the same.
- An early Senate version of the bill had depreciation changing from 39 years to 25 years, but the previous standard was ultimately kept.
- The new law restricts taxpayers from deducting losses incurred in an active business or trade from wage or portfolio income; this will apply to existing investment, and it becomes effective in 2018.
These Deductions Could Have Implications for Marketplace Lending
Real estate developers who opt for crowdfunding their multi-family and single-family rentals should enjoy the same tax benefits as other developers, and investors buying equity in these projects should see the benefits, as well. Check with your tax advisor for specific tax advice for your unique situation.
Ultimately, single-family home buyers and owners could see a disadvantage with the new tax bill while anyone who has anything to do with rentals should see this as good news.
As usual, this is not tax advice. Investors, developers, and all real estate property owners should consult their own tax advisors and perform their own due diligence to make the most of the 2018 tax laws.