What Do the New Tax Plan Changes Mean for You?

Two weeks ago, we gave an overview of ways you can reduce your taxes, including some great advice from our friend, tax expert and author Tom Wheelwright. You’ll find that post here: “Slash Your Taxes: Tax Reduction Tips for 2018.” Today, we dive more deeply into the new tax plan — explained in English!

What impact will the tax cuts and revised IRS rules have for you? What does the new tax plan mean for home owners, business owners and investors—especially real estate investors? Will your taxes be lower, or should you change strategy to avoid higher taxes? Let’s find out!

You’re probably paying less in taxes.

While often referred to informally as the “Trump Tax Plan,” the legislation signed on November 2, 2017 is also known as the Tax Cuts and Jobs Act of 2017 (or TCJA). The new tax rates go into effect for the year 2018, so it didn’t impact the return you filed in 2018, which was for tax year 2017. It will affect the tax return you’ll file next year, and you might already be seeing more money in your paycheck as an employee or lower estimated taxes as a business owner.

The following charts from Business Insider give a summary of how your tax rate might change:

To summarize the charts:

• the rates of most brackets are 1 to 4% lower than previously
• most brackets have adjusted upwards for inflation
• standard deductions have increased, and
• personal exemptions are eliminated.

The plan will benefit most taxpayers at all income levels, although large families (with three or more children or dependents) may see their taxable income go up.

Deductions for some homeowners have changed.

Some people will discover their mortgage interest tax deduction has become irrelevant under the new tax plan. Since the TCJA increases the standard deduction for each filing status, fewer homeowners will find an advantage in itemizing their deductions instead of taking the standard deduction. Your taxes will be simplified and your tax rate may be lower, but you may lose some previous deductions. For instance, if your family pays $1500/month in mortgage interest and you have little else to write off, you’ll be taking the standard deduction instead.

On the opposite end of the scale, you may find your mortgage interest tax deduction has shrunk if you were maximizing it before. Previously, you could deduct interest on up to $1 million of mortgage debt from your income. For homes purchased before December 15, 2017, that is still true. (Refinances on such homes are also grandfathered in.) For homes purchased after that date, the limit of deductible mortgage interest is now $750,000. If you are married and filing separately, you can only deduct half of that—$375,000 or $500,000, respectively. Mortgage interest on second homes is still deductible, provided the total deduction does not exceed the new limit.

Mortgage interest from a HELOC (home equity lines of credit) will no longer be tax deductible unless it is used “to buy, build or substantially improve the taxpayer’s home that secures the loan,” according to the IRS. If a HELOC is used as part of a purchase, that is deductible as it was used to buy the home. Essentially, the deduction remains if the interest is used to acquire or improve your home, but you can’t use the equity in your property to pay for other things and write it off.

Property tax deductions have been curtailed significantly. As a Forbes article details, all property taxes paid to state and local governments could be claimed as an itemized deduction under the old tax law (assuming you didn’t pay the alternative minimum tax). You could also deduct state and local income or sales taxes. The new law bundles all these taxes together and limits the total deduction to $10,000 for both individuals and married couples. If you live in tax-happy states such as New York, New Jersey, Connecticut and California, this is not good news.

Most homeowners who move for work will no longer be able to write off moving expenses. This will also be bad news for homeowners trying to flee high-tax states! Only military personnel whose move qualifies as a permanent change of station (PCS) will qualify for certain deductible moving expenses.

The new tax plan will impact some investors and many business owners.

Retirement plans and paper securities will remain largely unaffected by the new tax plan, although limits to most retirement plans will increase slightly for most plans in 2018.

There are also no real changes in the capital gains tax structure. Long-term capital gains are still defined as gains made on assets held for over a year, while short-term capital gains come from assets held for a year or less. Long-term gains are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket. (There are some minor differences in capital gains tax brackets, as this Fool.com article outlines.) Short-term gains are taxed as ordinary income, which offers some tax reduction, as tax rates have been reduced for most tax brackets.

However, there are significant changes that affect business owners and real estate investors. Our friend Tom Wheelwright outlines a few of the Trump tax plan “wins” in this short video clip:

Drivers Wanted: Good news for auto manufacturers and business owners.

The new tax plan will likely assist in funneling dollars to Motor City’s auto industry, which has showed signs of revitalization in recent years. Business owners who use their vehicles for a minimum of 50% business use vs. personal use will see big depreciation benefits for new vehicles. The new tax plan permanently increases the so-called “luxury auto” depreciation allowances.

Maximum allowances for passenger vehicles placed in service in 2018 are:

• $10,000 for the first year (or $18,000 if first-year bonus depreciation is claimed… a bonus that will disappear in 2026 without further Congressional action)
• $16,000 for the second year
• $9,600 for the third year
• $5,760 for the fourth year and thereafter (until the vehicle is fully depreciated.)

Prior allowances for passenger vehicles were $11,160 for year one for a new car with additional first-year bonus depreciation, $5,100 for year two, $3,050 for year four, and $1,875 for year four and beyond. Slightly higher limits applied to light trucks and light vans. The TCJA allowances will be indexed for inflation and reduced proportionately for vehicles with less than 100% business use.

If you use a heavy (over 6,000 pounds) SUV, truck or van in your business, it gets even better. The TCJA allows unlimited 100% first-year bonus depreciation for qualifying new and used assets that are acquired and placed in service between September 28, 2017, and December 31, 2022. (The depreciation bonus was previously 50% under the old tax law.)

As Tom likes to say, the tax code exists to incentivize certain taxpayer behaviors. And it’s clear that President Trump and Congress are incentivizing jobs, growth, real estate investment, and business ownership. Both business owners and the car industry will benefit from the new generous first-year deductions for business vehicles.

Of course—you’ve got to be careful to follow the rules carefully when you’re deducting for vehicles for business use, along with those business meals and other deductions!

Corporate taxes are significantly lower.

The TCJA cuts the top corporate tax rate from 35 percent and gives corporations a flat 21 percent tax beginning in 2018. Under the previous law, C corporations paid graduated federal income tax rates:

• 15% on taxable income under $50,000
• 25% on taxable income of $50,001 to $75,000
• 34% on taxable income from $75,001 to $10 million, and

Personal service corporations (PSCs) in which business owners provide at least 20% of the company’s service themselves paid a flat 35% rate. The new 21% flat corporate rate applies to PSCs as well.

The corporate dividends deduction, however, has been noticeably reduced. CPA Rick Woods explains the details in this article for CPAs and advisors on the new tax breaks for businesses.

Overall, it is still a large tax break that will likely incentivize more business start-ups in the US, and fewer businesses moving elsewhere.

Taxes are lowered on “pass-through” businesses.

One of the most significant provisions of the tax bill affecting real estate investors is the 199A pass-through deduction. This allows you to effectively reduce your marginal tax rate by up to 20%—no small benefit! Pass-through businesses are corporate entities that allow business income to “pass-through” to the owner, thereby paying a personal income rate, as opposed to a business rate. They can include partnerships, S-corporations, sole-proprietorships and LLCS’s (limited liability companies), and income from rental properties (including income passed through from REITs). This tax cut helps to even the playing field between larger corporations and small business owners.

There are exceptions for who can claim this deduction. One limitation is income. For pass-through entities to qualify, total annual income must be less than $157,500 for single filers and $315,000 for those who are married and file jointly. Another limitation is based on the type of business. Owners of “specified service businesses” cannot use the pass-through deduction if their income exceeds certain thresholds. This list provided by the IRS includes doctors, lawyers, consultants, accountants, and brokers, advisors and managers providing financial services. Some small business owners, however, will be able to take partial deductions.

Confused? You’re not alone, which is why the IRS is continuing to provide clarity in response to questions. This Fool.com article may help: “What We Know About the 20% Pass-Through Tax Deduction (So Far)”. Tom Wheelwright also did an excellent podcast on this topic: “Shave 20% Off Your Income Tax.”

Residential landlords who operate as pass-through entities can deduct 20 percent of net rental income right off the top. There are also caps for rental property investors. Reports Money.USNews.com, the 20 percent deduction is capped by whichever is greater: 50 percent of wages or 25 percent of wages plus 2.5 percent of the unadjusted basis of qualified property held by the business, says Rob Crigler of Mariner Wealth Advisors in Madison, New Jersey. The property must be a rental property that’s subject to depreciation, and the unadjusted basis is the property’s original cost, without depreciation.

Traditional C corporations are not pass-through entities. If you’re wondering which is right for your business, read this MarketWatch article: “Should Your Business Be a C Corporation or Pass-Through Entity? What Makes Sense Under the New Tax Law.” And, of course, consult your tax advisor!

Investments in distressed and lower-income communities are incentivized.

Depressed areas should see a flurry of new dollars under the new tax plan. Real estate investors willing to put money into “opportunity zones” and stayinvested for five or more years can defer capital gains until they divest or until 2026, whichever comes first. This will attract new dollars AND encourage investors to make sustainable investments. Even better, reports Forbes.com, is a capital gains bill of zero on new gains for investments held 10 years. The IRS just announced the final round of Opportunity Zones and has published FAQ.

As we have seen, quick “flips” can actually have negative consequences on a neighborhood if real estate prices are driven up too quickly by speculators. Perhaps that is why, as U.S. News and World report states, “the law’s new provisions especially favor rental properties.” We are also seeing some cities suffering from a shortage of rental properties. The new tax law should help rectify that by incentivizing investors to be landlords to buy and hold rather than flip.

Find out more about the advantages of investing in opportunity zones here, and find out which census tracts qualify with this map from the Economic Innovation Group.

Great news for real estate investors investing anywhere!

In his recent presentation for the Cash Flow Wealth Summit, Tom went into more detail on why the new tax code is so advantageous for real estate investors. Here are our notes based on the presentation:

If you purchase real estate as an investor, about 30% is now going to be deductible because of bonus depreciation. Here’s how that works: When you buy a house, you buy the house, you buy the land, and you’re also buying other things… window coverings, ceiling fans, flooring, towel racks, fencing, light posts, landscaping, free standing garages, contents, etc. These are your “improvements.”

The land doesn’t depreciate, so there’s no deduction for that. The building will be depreciated at about 3-1/2 percent a year. However, the land improvements—the contents, landscaping, etc.—is going to be deductible in year number one. That’s going to be deductible in the first year, and typically on real estate, that’s might account for about 30 percent of a property.

Here’s the significance of this: You might only put 20% down on a property. With a $100k property, you could put $20,000 into a piece of real estate and get a $30,000 deduction. There is no other place you can do that in the U.S. other than real estate!

Tom’s winning combination for real estate investors.

Continuing with the same example… Tom explained why investing with real estate using cash from a whole life policy can make a real estate deal even better! If you’ve been building up your savings in a life insurance policy, you can borrow against cash value life insurance for your down payment. In this case, you’re getting into the property using the life insurance company’s money—and the interest on that is also deductible! So you’re getting a big tax savings right off the bat while you’re leveraging other people’s money to expand your assets.

We at Partners for Prosperity have always recommended combining real estate investing (for those who enjoy it) and high cash value whole life insurance. They BOTH build equity and put dollars to work doing multiple “jobs,” and they work together very well. Real estate provides excellent upside potential while the life insurance provides liquidity for the deals, as well as stability that balances the unpredictable nature of real estate investing.

You DON’T want to miss this!

Tom Wheelwright has just updated his book, Tax-Free Wealth for the new tax plan! This has been our favorite book for savvy tax strategies, and we’re thrilled we’ll be able to recommend the updated version. You can find Tax-Free Wealth on Amazon here. (It doesn’t look like the kindle and audio versions are updated yet, so make sure you get the second edition paperback!)

Stay tuned for more…

The new tax plan also has brought some changes and opportunities to life insurance and the life settlement industry. Charitable giving deductions are also impacted. We’ll be back with future posts with more details to explain how the Tax Cuts and Jobs Act affects those areas. (Sign up here to stay in the loop—and get some of our best resources—on us!)