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larrywww

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These are my initial reactions although in terms of taking any actions, as always, I would consult your tax advisor. 

1. With regard to deducting mortgage interest, I have seen some authority that already existing mortgages would be “grandfathered” and that this would apply only to new mortgages.  But I don’t know that for sure—I haven’t researched it.  In any case, in regards to new houses bought after 2018, the mortgage interest deduction is limited to houses costing $750,000.

2. Another last minute change: They didn’t change Section 121 to require a 5 year holding period (out of 8 years).  The same 2 year rule still applies.

3.  State and local tax deduction is limited to $10,000 for property tax. 

4. Some tax advisors recommend prepaying deductions that will go away in 2018, but I am not sure that will work---haven't researched it.

5. Some economists predict something like a 4% to 10% decline  in house prices----which doesn't necessarily mean that prices will go down but that appreciation may be non-existent or less---especially at the higher end of the market. 

6. One last minute change: They repealed the individual mandate penalty of Obamacare, but made it effective in 2019.   So the tax penalty still exists, though whether it is going to be enforced may be another question.  What they did NOT do was get rid of the 3.8% obamacare tax----mainly because they needed this income to make the overall tax cut to corporations, etc work.

This is what CBS News said about this whole issue (which is complicated, actually).

Trump claim:  "Obamacare has been repealed in this bill."

The facts: It hasn't. The tax plan does end fines for people who don't carry health insurance, which is a big change, yes, but far from totally dismantling the law.


Mr. Trump said at a meeting with his Cabinet, "When the individual mandate is being repealed, that means Obamacare is being repealed," adding, "We will come up with something much better." 

Other marquee components of Obama's law remain, such as the Medicaid expansion serving low-income adults, protections that shield people with pre-existing medical conditions from being denied coverage or charged higher premiums, income-based subsidies for consumers buying individual health insurance policies, the requirement that insurers cover "essential" health benefits, and the mandate that larger employers provide coverage to their workers or face fines.

Also, the tax bill doesn't repeal fines for uninsured individuals until the start of 2019, meaning the "individual mandate" is still in force for next year unless the administration acts to waive the penalties.


Trump: "When you add it all up together, and then you add two things — the individual mandate is being repealed. When the individual mandate is being repealed, that means Obamacare is being repealed because they get their money from the individual mandate. "

The facts: This is also wrong. The fines on people who don't carry health insurance only provide a small fraction of the financing for the program. Most of the money comes from higher taxes on upper-income people, cuts in Medicare payments to service providers, and other tax increases.


The Congressional Budget Office estimated that fines from uninsured people would total $3 billion this year, stemming from its projection that 2 million fewer people would pay the penalty for being uninsured in 2016. It predicted the government's cost for the coverage provided under the health law would total about $117 billion.

 

larrywww

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Reply with quote  #2 
The Norris Group just released an emergency interview with CPAs Amanda Han / Matt McFarland on what to do in response to the 2017 Tax Bill.

Given that some of their advice is to take action before 1/1/2018, it is very timely advice.  

https://www.thenorrisgroup.com/bruce-norris-joined-amanda-han-matthew-macfarland-real-estate-radio-show-570/
SFL

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Reply with quote  #3 
According to the below, it looks like otherwise non-deductible state income and property taxes due in 2018 cannot be made deductible by pre-paying them in 2017.  

https://www.cnbc.com/2017/12/18/prepaying-2018-state-income-taxes-is-blocked-in-gop-bill.html
larrywww

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Reply with quote  #4 
I think that's true---although it's not like I have read the entire (very voluminuous bill).  But even assuming so, I'm not sure that is true of all the other tax changes.

I only bring up the prepayment angle because sometimes that is a viable strategy where Congress changes the tax rules and hasn't specifically outlawed it.  For example, I have seen some suggestions that prepaying tax preparation fees might still work.  I don't know---I haven't researched the issue.

The truth is that alot of complexity has been dumped onto the investing public without alot of time for analysis----which is why I appended the caveat about not having researched the issue.

I should also say that I looked for other tax analyses on Youtube, etc----and found nothing really useful yet except the video from the Norris Group.
larrywww

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Reply with quote  #5 
I'm not an accountant, but here is an update in terms of the prepayment strategy.

The Washington Post recommends prepayment, including property taxes (though with the approval of your accountant since the AMT tax may come into play).

According to the Post, the drafters of the bill tried to prevent this strategy (and Thanks SFL for pointing that out), but they made a legal mistake in terms of the language used and it doesn't appear they are going to correct the mistake.  If not, it might be worth a shot.

They also recommend trying to prepay other taxes.  And delaying income until 2018 when the tax brackets may be lower.

https://www.washingtonpost.com/news/wonk/wp/2017/12/22/5-things-to-do-before-jan-1-to-lower-your-tax-bill/?tid=pm_pop&utm_term=.7cc7f8215d06
Lara

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Reply with quote  #6 
Quote:
Originally Posted by SFL
According to the below, it looks like otherwise non-deductible state income and property taxes due in 2018 cannot be made deductible by pre-paying them in 2017.  

https://www.cnbc.com/2017/12/18/prepaying-2018-state-income-taxes-is-blocked-in-gop-bill.html

It looks like it is only true for income taxes, but you can probably still pre-pay your property taxes: "The final version of the tax legislation includes a provision that would disallow a deduction in 2017 for any prepayment of 2018 state and local income taxes (otherwise known as SALT)."
SFL

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Reply with quote  #7 
I wasn't able to access the Washington Post article, but as mentioned above as well as elsewhere on the Internet, it looks like the pre-payment prohibition specifically refers to state and local income taxes, but does not refer to property taxes.  Thus, many advisors seem to be suggesting that 2018 property taxes under certain circumstances be pre-paid if possible, but that this may not be allowed for state and local income taxes attributable to 2018.  

In my view, the two big arguably positive things accomplished by the tax bill are the following:

1.  To reduce the income tax rate of C corporations (most large companies).  Until recently, both parties have agreed that this was necessary for international competitiveness.  

2.  To stop the tax code from subsidizing excessive investment in housing for personal use (e.g. subsidizing McMansions), and from subsidizing excessive leverage in most businesses (but apparently exempting real estate businesses)

And the biggest disadvantage of the tax bill is that the deficit will grow because such a large portion of the lost revenues are not offset.

At first glance, the tax bill doesn't seem like it should be too disruptive to most real estate businesses.  Mortgage interest deductibility is still allowed on mortgage principal not to exceed $750K, which can be attributed to one's primary residence as well as to one second residence.  Property tax and state income tax expenses are still deductible up to a combined total of $10K/year.  Under these circumstances, I doubt that most middle-income people who otherwise would be in the market for a home will decide to rent instead.  

I think it would have been quite disruptive to change the holding requirement for eligibility for capital gains exemptions on primary personal residences from 2 years to 5 years, as had been discussed.  But this did not happen; the old rule still stands.  

If you are in the rental business and you have mortgages on rental properties, I doubt that the deductibility of these would be reduced.  The general principle (subject to exceptions) has always been that business expenses are deductible, while personal ones are not.  

As mentioned above, the tax bill took aim at highly leveraged entities by only allowing a deduction of interest expense up to 30% of EBITDA - but apparently the real estate industry has been exempted from this.  Since the RE industry tends to be highly leveraged, this could have been disruptive.  But again, the RE industry appears not to have been affected by this.  (The LBO and Private equity industry is affected)

Tackling excessive leverage is a good thing, and I doubt that democrats will clamor to reverse those rules.  There is no political appetite for bailing out over-leveraged corporations or mansion owners in future downturns. 

I also think it will be difficult to reverse the new deductibility restrictions affecting property taxes and state income taxes.  A few months ago, I wouldn't have expected these restrictions to be passable, but now that they have passed, I think they will be difficult to reverse.  

We may also be reaching the limits of tax revenues raisable in the form of individual income taxes.  Under the current circumstances, will NY, NJ and CA again raise income taxes on their "rich" another few percentage points next time they need money?  I think they will find this increasingly difficult.  

For the first time in a very long time, using C corporations rather than pass-through entities could be a viable option again for small and mid-size businesses. 

It will be interesting to see what happens.  The tax landscape sure has changed.  But it will be adjusted again, probably within the next few years, life will go on, and - we often forget this - the world will continue to get wealthier.  

(There may be some factual errors in this post; the figures above are from memory)
mks_97

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Reply with quote  #8 
So looks like this tax bill is going to be really beneficial for Real estate investors for the following reasons:

. If you have a rental portfolio that has a positive cashflow, guess what, you can take another 20% off before it is considered as taxable income (there are some caveats like can't be greater than 2.5% of the capital invested etc.). You do not have to hold properties in any entities for this as it will show up in schedule C or E.

. If you flip homes, you can take another 20% off the income you make.

. If you buy capital equipment for rental properties and they have less than a 15 yr lifespan, you can depreciate 100% it in the first year itself (bonus depreciation). So if you buy a rental property and segregate it into its components, you could depreciate a large part of the cost of the purchase in the first year itself!

However of you invest in trust deeds, you cannot avail of the 20% pass through deduction as it only applies to business income (ie not to interest income, dividends, capital gains)
larrywww

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Reply with quote  #9 
I thnk it's true that the law has some positives for real estate investors, even if larger companies are arguably the prime beneficiaries.

One subtle benefit is that the tax brackets for individuals have also been changed and the rates that apply to them---although the changes expire in 2025.  https://taxfoundation.org/final-tax-cuts-and-jobs-act-details-analysis/

What is also confusing are some deductions that were threatened but never repealed.

Thus, the $7500 credit for electric cars had been threatened---but it wasn't repealed.   https://www.usatoday.com/story/money/cars/2017/12/19/electric-car-buyers-still-get-incentives-under-tax-bill/964543001/

What they did with the individual mandate is a little confusing because Trump keeps claiming Obamacare has been repealed, etc.

Technically, what I've heard is that the statuorily mandated penalty has been reduced to zero---so there is no penalty for failure to buy health insurance. This will take effect in 2019, so the mandate still applies in 2018.  Although who knows what will happen?  The Republicans are promising to take yet another crack at it---your guess is as good as mine.

Figuring out the penalty isn't exactly straightforward, but here is what they say.  
https://www.healthcare.gov/fees/fee-for-not-being-covered/.  My understanding is that if you don't qualify for subsidies, the maximum penalty would be the cost for a bronze plan----so that it might still make sense to at least get a bronze plan if you are going to end up paying for it anyway.   Although it's a little confusing since they didn't enforce the penalty in 2016 and who knows how this is going to be handled in the future.

Otherwise, I don't believe that it is accurate to say that Obamacare has been repealed----although areas of it have been weakened so clearly there are some issues.  I'm not sure what happens in the future, but until it is repealed the insurance companies are required to keep participating (assuming they don't quit the exchange)---although they are permitted to raise prices.  And the subsidies are statutorily mandaged---insurers are obligated to honor those until there is a full repeal---whether or not Congress allocates funds to repay insurers for subsidies.  What alot of insurers are doing is pricing their coverage based upon the assumption they won't receive subsidies----so prices have risen.  The individual market will remain open until 1/31/2018 so there is still some time (although the policy will start later than 1/1/18)----however, under the penalty section they indicate that a lapse of coverage less than 3 months probably won't be penalized.  So, there is still time to address the issue.

The main thing that I am VERY glad is that they didn't severely modify the Section 121 provisions for the sale of a primary residence----this is a really huge tax break.  This is one of the smartest tax moves----only behind the other really smart tax move----if you have a grandparent why not transfer substantial property to them?   Swap till you drop----Bill Exeter is a genius.

But I'm no tax expert.  Each time I read the bill I find something new.  The Alternative Minimum Tax still exists, for example, but there are substantial exemptions so fewer taxpayers pay it.  The 3.8% investment tax still exists, for example, for single taxpayers with an AGI over 200K and married couples with an AGI over 250K.  But there are small tweaks everywhere that you tend to miss until you go over things again.  The real truth is that a tax bill drafted in 9 weeks in private (in 1986 they took 2 years with congressional hearings) is going to have a ton of unseen loopholes, drafting mistakes, etc especially because although the aim was to simplify the tax code they did the exact opposite.   The CPA firms are on a treasure hunt as we speak looking for exceptions that swallow these tax rules.
larrywww

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Reply with quote  #10 
It turns out that whether or not to prepay your taxes this year is a somewhat complicated question.

The tax bill forbids prepaying state and local taxes before the law takes effect, but no similar prohibition was included against prepaying property taxes.

But you first need to determine whether you are going to get any tax benefit---even it is advisable for you to itemize next year.

https://www.washingtonpost.com/news/wonk/wp/2017/12/27/essential-questions-and-answers-about-prepaying-your-property-taxes/?hpid=hp_hp-top-table-main_propertytax-wb-445pm-%3Ahomepage%2Fstory&utm_term=.b89ea204696a
Jeff

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Reply with quote  #11 

Quote:
Originally Posted by larrywww


...only behind the other really smart tax move----if you have a grandparent why not transfer substantial property to them?   Swap till you drop----Bill Exeter is a genius.

 

I have never heard of this...can you please tell me a little more about it?


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Jeff

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Reply with quote  #12 

This whole thread is interesting! 

 

Thanks to all who helped educate me here...


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SFL

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Reply with quote  #13 
Quote:
Originally Posted by Jeff

 

 

I have never heard of this...can you please tell me a little more about it?



I can't speak for Larry, as I don't know exactly what he has in mind, especially regarding the Grandparent scenario.

Bill Exeter has a presence on YouTube, just google "Bill Exeter 1031".  1031 exchanges if done intelligently can be great for deferring taxes on gains.  However, if not done intelligently they can also easily lead to disaster. 

There are lots of stories about long-term property owners who, in the hopes of saving taxes, decide to do a 1031 exchange rather than selling their property outright (or simply keeping it).  If they 1031 into a TIC scheme, there is a good likelihood that they are exchanging a good property which they control, for an interest in an overpriced property which they do not control.  Add too much leverage, and they can lose it all.   So you've got to know what you're doing and not just listen to promoters whose interests are not aligned with yours.  But again, done right, 1031 exchanges can be a great way to defer taxes.

I would think that the toughest problem with 1031 exchanges is finding a good property to 1031 into, and to do so within the allowed time frame (6 months?).  It is never good to be a desperate seller or a desperate buyer, and being committed to a 1031 transaction with your property already sold and the next one not yet found could turn you into a desperate buyer.  Not a good place to be. 

I would bet that almost all of the people who do 1031 exchanges successfully are active and experienced in the RE business, with a good understanding of pricing and markets, and more able than most to sell high and buy low. 

But for most people who aren't in the business, when you can get a great price for the property you are selling, then you are probably also having to pay through the nose for the replacement property.  Or, if you are getting a replacement property for a great price, you probably won't get a very good price for the property you are selling.

It is good to know that the 1031 option is out there and it is good to have an understanding of the rules, but you have to be able to "just say no" unless all of the pieces of this complicated puzzle are in place and the end result would be clearly and obviously favorable to you.  

Regarding the grandparent scenario, this wasn't explained so I'm not sure exactly what this entails.  However, I would guess that a piece of that puzzle is the fact that someone who dies with appreciated property gets an automatic "step-up in basis", so that no tax is due on the gain when that property is sold.  Thus, if the estate of a deceased person has a property worth $1M for which the decedent originally paid $200K, the heirs can sell the property for $1M without owing any capital gains tax.  If that same person would have sold just prior to dying, taxes would have had to be paid on the $800K gain, and those taxes are considerable, especially in CA.  So the tax benefit of not selling until you die is very considerable.  The problem, of course, is that you're dead so you won't benefit from this.  But your descendants will, if you've decided to pass your wealth on to them.  

In theory, and in certain situations, this could make it attractive to arrange things in such a way that a soon-to-be-dead person ends up with highly-appreciated assets, which then get passed to following generations with a stepped-up basis.  But this can get very complicated for all kinds of reasons, including legal ones as well as ones relating to human nature.

Anything that allows you to save a whole bunch of taxes which almost everyone else is paying, is likely to subject you to the scrutiny of the tax authorities.  The rules are generally complicated and must be followed to the letter.  

In practice, the idea for these types of arrangements would almost always have to originate with the grandparent, who would have to be of sound mind while executing any documents.  The grandparent, if of sound mind, would also be best able to foresee and fend off any potential family problems.  




SFL

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Reply with quote  #14 
It will be interesting to see how the categories of properties that typically are used as high end second homes will fare over the next few years.  

For middle class housing, the difference shouldn't be huge.  The people with $400K primary residences who are purchasing $200K vacation homes won't have any trouble meeting the $750K maximum mortgage interest deductibility requirement, and property taxes will be relatively modest even if they to some extent no longer may be deductible.  

For people with expensive primary residences who already have fully utilized the mortgage interest deductibility allowance as well as the property tax deductibility allowance, the equation for second residences is quite different.  If they are in the 35% bracket, then their post-tax bill property tax and interest expenses attributable to these second residences will increase by over 53%!  This holds for qualified boats and RVs as well (boats with a galley and a built-in head can be qualified as second residences for mortgage deductibility purposes, ditto for RVs).

This should have a chilling effect on the sale of expensive second homes to buyers using borrowed money.  It could have the secondary effect of benefiting the vacation rental market, as more people may elect to rent vacation housing rather than to own it outright.

Interesting also is the very high end of the market.  After the $750K and 10K deductibility limits have been reached, the person buying the $5M or $50M house is also seeing his actual (post-tax) mortgage interest- and property tax expenses increase by over 53%.  This has got to have an effect.  

Sure will be interesting to see how this unfolds.  Looks like middle-class housing should remain relatively unaffected.

(I didn't take state taxes into account in the above calculations; only federal taxes.)
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