As you may be aware, year-end 2017 presents a unique set of challenges and potential opportunities in light of the uncertainties created by the proposed tax changes. What changes might be made and whether those changes will be effective for 2017 is still largely unknown as of today. To make sure we do our best to prepare for the pending changes, we have put together a list of some important items for you to consider.
Over the coming weeks we may finally have better information with respect to any final tax changes that may impact 2017 and 2018. For now, flexibility and preparedness are key. For most of us as taxpayers, there is no urgent need to take drastic action at this time. Rather, we should be ready to do so as late as end of December. This means being ready to take action on any tax opportunities as well as having liquidity to make investments, purchase assets, or prepay expenses in order to capitalize on any finalized tax benefits that may impact us in 2017.
Under the current proposal, many of the personal itemized deductions may be repealed or limited starting in 2018. Should these changes be enacted for 2018, it can make sense for us to prepay some of these expenses in 2017 in order ensure we receive the tax benefits now rather than lose them next year. Some examples of these include out of pocket medical expenses, primary home property taxes, state income taxes, DMV fees, investment expenses such as brokerage fees, tax preparation fees, moving expenses, and unreimbursed work-related expenses. However, since these changes are still pending legislation, there is no urgent need to run out and prepay all of these at this time. Although we may want to be prepared to do so should the tax changes take place by year-end.
The proposals include a change to the primary home gain exclusion to those who live in the home for the last 5 out of 8 years. This benefit may also be phased out for taxpayers of higher income. However, if the home has a written and binding contract by 12/31/17, it may still fall within the 2 out of 5-year rule even if the sales transaction does not close until 2018. So if you are in the process of selling your primary home and do not currently meet the proposed 5 out of 8 year requirement, it can make sense to get that contract signed by year-end 2017 if the proposal were to be passed.
The ability to convert traditional IRA into a Roth IRA and undo that conversion in the subsequent year may also be on the chopping block. As such, if you were interested in potentially moving funds from taxable IRA into a Roth IRA, doing so by 12/31/17 may be your last chance to un-do that conversion in 2018.
With respect to kids, the proposal may allow 529 plans to be used for K-12 elementary education for public and private schools for the first time. This may be a significant benefit for those who are interested in funding 529 plans for future education purposes.
Business and Real Estate
Under the current proposal, one change that may be beneficial to business owners is the potential of taking 100% bonus depreciation on assets placed in service after 9/27/17. For example, if you buy new equipment costing $15,000 for your flip business, it may be possible to take a 100% deduction for this immediately in 2017. If you are in the market for new assets to use for your business, it can make sense to start shopping now, but hold off on making any actual purchases until we know for certain whether this tax benefit will pass and apply to the 2017 year.
For the first time in a long time there may be some great news for real estate investors. Under the proposal, we may be able to receive faster depreciation on rental properties starting as early as 2018. Depreciation of residential and commercial rental properties may both be reduced to 25 years which results in larger deductions each year. If you recently purchased a commercial property in late 2017, it can make sense to wait to place it in service until 2018 year in order to take faster depreciation next year.
A few key potential changes under the proposal for 2018 may be lower personal tax rates as well as lower tax rates for C Corporations and flow-through entities such as LLCs and Partnerships. In light of the potentially lower rates for 2018, it can make sense to shift expenses into 2017 to receive tax deductions at the current higher rates. Prepaying business expenses such as marketing fees, lease expenses, legal and professional fees may be a good move. Look ahead and prepay some of the anticipated 2018 expenses by 12/31/17 to help reduce taxes for 2017 and create permanent tax savings before the rates are lowered. Expenses charged on a credit card by year-end may be legitimately deducted in 2017 even if the credit card is not paid off until a future year.
Since lower tax rates are anticipated for 2018, it can also make sense to defer income into 2018. For example, if you are a realtor expecting a large commission check, if you don't receive your check until after 12/31/17, then the taxes may be assessed on lower tax rates if the tax proposals were to be passed for 2018.
A potential pitfall in the current proposal could limit interest expenses to be only deductible up to 30% of the business income. For example, if you own an online business with a net profit of $100k and interest expense of $40k in 2018, it is possible that you may only be able to deduct $30k of it in 2018 against your income. If this tax change were to happen for 2018, it can make sense to prepay your interest expense in 2017 since there are currently no limits on interest deductions against business income. If it were to pass, it is unclear whether this limitation on interest expense applies to rental real estate investors or small business owners such as realtors and flippers. For those flipping real estate, it is only recommended to prepay any interest for those properties that will be sold by 12/31/17.
Another pitfall in the proposal may be the repeal of business related entertainment expenses starting in 2018. So, if you were planning on a nice holiday party or gathering for your office, it can make sense to prepay for those in 2017. Currently certain meal expenses such as food and beverage provided at an open house by a realtor can be eligible for 100% deduction. Under the proposal, it may be limited to 50% deductibility starting in 2018.
With all the potential changes, this can be both an exciting and nerve wrecking time for many of us as taxpayers. Among the variables we have in tax planning for 2017 and beyond, two constants continue to apply:
One - Getting the right numbers: Make sure your financials are up to date. Spend the time now to update your profit and loss so you know where you stand currently with respect to all of your income and expense items. Having $20k of income vs $50k of income can have very different tax strategies. Ensuring your financials are up to date helps you to accurately take advantage of any last-minute tax changes and also helps to save you from unnecessary stress come next April.
Two - Keeping the line of communications open: Make sure you keep us updated on any significant changes or transactions that occur throughout the year. By letting us know about your upcoming transactions, we can help you to make informed decisions on any considerations and take advantage of any tax opportunities that may result from any final tax changes.