Thanks to NAR advocacy efforts, the Tax Cuts and Jobs Act contains several favorable provisions for individual real estate professionals
That’s the general REALTOR® response to the tax reform law, which while diminishes the tax benefits of homeownership and will cause adverse impacts in some markets, could have been a whole lot worse.
Advocacy efforts by NAR as well as consumers resulted REALTOR®-favored elements to the Tax Cuts and Jobs Act, such as the exclusion for capital gains on the sale of a home; the preservation of the like-kind exchange for real property; and the omission of early language that would have subjected independent contractors to an additional 5 percent withholding requirement. In addition, many agents and brokers who earn income as independent contractors or from pass-through businesses will see a significant deduction on that business income.
Read on for details about the impact of the Tax Cuts and Jobs Act on you as a real estate professional (giving you plenty of time to prepare for filing your 2018 taxes) or click here for information about the impact of tax reform on current and potential homeowners, and the resulting implications for the housing market and the real estate industry.
MAJOR PROVISIONS AFFECTING REAL ESTATE PROFESSIONALS
DEDUCTION FOR QUALIFIED BUSINESS INCOME
Because the new tax law greatly decreases the tax rate for corporations (from the prior law’s 35 percent to just 21 percent), many members of Congress believed that the business income earned by sole proprietors, such as independent contractors, as well as by pass-through businesses, such as partnerships, limited liability companies (LLCs), and S corporations, should also receive tax rate reductions. In addition to lower marginal tax rates, the final law provides a significant up-front deduction of 20 percent for business income earned by many of these businesses, but with certain conditions.
Specifically, the law limits the 20 percent deduction to non-personal service businesses. Essentially, a personal service business is one involving the performance of services in the following fields: health, law, consulting, athletics, financial services, brokerage services (not real estate), and “any business where the main asset of the business is the reputation or skill of one or more of its employees or owners.”
It seemed clear that most real estate agents and brokers would be considered in a personal service business and would thus not normally qualify for the 20 percent deduction.
However, NAR advocacy efforts helped to secure a major exception (the personal service income exception) in the final law that will make it possible for many real estate professionals to be able to take advantage of the deduction.
This exception provides that if the business owner has taxable income of less than $157,500 (for single taxpayers) or $315,000 (for couples filing jointly), then the personal service restriction will not apply. Above this level of income, the benefit of the 20 percent deduction is phased out over an income range of $50,000 for singles and an income range of $100,000 for couples.
For those with non-personal service income above these thresholds, the law provides a second exception that may still allow a full or limited 20 percent deduction. This second exception (the wage and capital limit exception) places a limit on the deduction of the greater of:
50 percent of the W-2 wages paid by the business, or
The total of 25 percent of the W-2 wages paid by the business plus 2.5 percent of the cost basis of the tangible depreciable property of the business at the end of the year.
Bottom Line: Independent contractors and pass-through business owners with personal service income, including real estate agents and brokers, with taxable income below the $157,500 or $315,000 thresholds may generally claim the full 20 percent deduction under the personal service income exception. Independent contractors and pass-through business owners with non-personal service income and total taxable income below these thresholds may also claim the full 20 percent qualified business income deduction. In addition, independent contractors (or other sole proprietors) with non-personal service incomes above these thresholds may also be able to claim a 20 percent deduction, but that deduction may be limited by the wage and capital limit exception.
SECTION 179 EXPENSING
The law increases the amount of qualified property eligible for immediate expensing from $500,000 (current law) to $1 million. The phase-out limitations are increased from $2 million to $2.5 million.
The law expands the definition of qualified real property eligible for section 179 expensing 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 law 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.
Denial of Deductibility of Entertainment Expenses
The law provides that no deduction is 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, or
A facility or portion of a facility used in connection with the above items.
Thus, the provision repeals the present-law exception to the deduction disallowance for entertainment, amusement, or recreation that is directly related to (or, in certain cases, associated with) the active conduct of the taxpayer’s trade or business.
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).