By Ryan Coon, CEO and co-founder of Rentalutions
While the unusually fast push-through of the Tax Cuts and Jobs Act raised eyebrows around the country, potential real estate investors have reason to cheer now that it's passed. The law, which will affect the taxes we file for 2018 (meaning those we submit in 2019) through 2025, includes several provisions that could make being a landlord more profitable than ever.
Here are highlights of the changes that are likely to have the greatest impact.
The new tax law offers a pretty cool win for landlords who operate as LLCs. It allows them to pay taxes on less of their income, which effectively lowers their tax rate. To take advantage of this benefit, though, you have to file as an LLC once you buy property and start renting. But that's a smart choice for many reasons. For example, it can also help lower your exposure to liability.
Here are the specifics:
- LLCs can now deduct 20 percent of qualified business income. In other words, if you operate as an LLC, you may be eligible to pay taxes on just 80 percent of the total amount you earn from rent.
- LLCs are pass-through entities, meaning the income generated by an LLC flows directly to its owner's personal tax return. If an individual is in, say, a 37 percent federal tax bracket with rental income, he or she would effectively pay 29.6 percent because of the new 20 percent rule. So while the tax rate itself wasn't lowered for LLCs, the outcome will be lower taxes for those organized in this way.
There are a few restrictions for those earning significant income from their rental properties. You can read all about them on our blog.
It's always good to get into the market when demand is high for what you're selling, and many experts think that the new tax law will mean fewer people buy homes. Translation: more renters.
That's because the new law makes it less advantageous (from a tax perspective) to buy a house. The outcome is that renting looks better by comparison, so people who were on the fence about buying may decide to rent longer.
There are three specific tax law changes that will potentially make buying a home less of a financial win:
- Increase of the standard deduction: Under the new law, the standard deduction nearly doubles to $12,000 for individuals and $24,000 for married couples filing jointly. This means that far fewer people will save money by itemizing deductions – including the mortgage deduction. Translation: one of the major incentives for buying a home is now gone.
- Limit on state and local property tax deductions: Today, homeowners can deduct state and local property taxes on their federal returns. The new law limits that deduction to $10,000 (for individuals and couples). In other words: one cost associated with homeownership is about to go up for many people.
- New limit on mortgage interest deductions: The new law lets homeowners deduct interest paid on mortgages up to $750,000, a drop from $1 million under the old law. Most U.S. homes are worth less than the new limit, but the change could have a ripple effect. People who were thinking of upgrading to houses worth more than $750,000 might now decide not to move, meaning the supply of less-expensive homes could be tighter than it otherwise would have been. This, too, could cause would-be homebuyers to keep renting longer.
Lower demand for homes (especially in more expensive coastal markets) will likely translate to lower home prices. If you've been thinking about buying a rental property, this is great news, especially if you're in a part of the country that tends to have higher home prices and higher taxes.
If you haven't seriously considered real estate as an investment, now may be the time to start.
One important thing to note here: everybody's individual situation is different, and there's no right path forward for every investor. What's more, the IRS hasn't yet issued guidelines on how to interpret the new tax law, so there may be additional wrinkles to consider once it does.
Before making any major decisions about your finances, be sure to consult with a CPA who can help you understand how changes to the tax code will affect you.
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