The ink was barely dry on the new tax law when it went into effect. Residential property investors likely have a lot of questions about what the law means for their tax situation.
Will your tax burden go up or down? What will the law do to property values and the rental market? Should you change your investment strategy (i.e., rentals versus flips?) based on changes the new law will bring?
A major benefit for real estate investors in 2018 is a new deduction on net rental income. If investors have set up their business as a pass-through entity—a sole proprietorship, partnership, limited liability company, or S corporation—they will be able to deduct up to 20 percent of their net rental income from their personal tax return.
As described in the law, calculating the deduction for qualified business income of pass-through entities can be fairly complex. However, there is good news for small investors: If your taxable income is less than $157,500 (single taxpayers) or $315,000 (married taxpayers, filing jointly), you automatically qualify for the 20 percent deduction.
Changes in Deductions
Two major tax-law changes—a new limit on mortgage interest deductions and the doubling of the standard deduction—are likely to have an impact on the residential housing market and on potential investor strategies. The new law allows deductions for mortgage amounts up to $750,000 for primary and secondary residences. The old law set the limit at $1 million, but only mortgages taken out after the new law went into effect will be subject to the $750,000 limit.
With the vast majority of homes costing less than $750,000, it may seem that the new mortgage limit won’t have a large impact other than in high-priced markets. However, the hike in the standard deduction (even with the elimination of the personal exemption) will result in a significant reduction in the percentage of homeowners who use the mortgage interest deduction. According to Zillow, less than 15 percent of homeowners will use the deduction under the new law—compared to 44 who used it under the old law.
As a result, homeownership will lose a tax advantage over renting for the majority of homeowners. The likely impact will be rising demand for rental property plus a dip in housing prices—in some markets by as much as 5 percent or more.
Rentals More Attractive
For investors, this readjustment in the market will make acquiring rental property a more attractive proposition than purchasing a property to flip.
Investors can maximize rental property income by emphasizing the benefits of renting over home ownership—i.e., no responsibility for home maintenance/repairs, no down payment, no real estate taxes, and no worries about declining home values.
Since ramifications of the new tax law are still shaking out, it would be wise to proceed cautiously when transitioning to a new investment strategy. This year, more than ever, it’s important to keep an eye on market trends and be ready to adjust your game plan as new information becomes available.
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5 Arch Funding is not a tax advice expert, law firm or accounting firm. The content of this article is informational only and is not intended as tax, legal or accounting advice. Consult your own tax, legal or accounting professional for guidance.