Lawmakers been talking a great deal about making a big push for tax reform since the election last November, and the House of Representative’s new tax bill is finally due to be revealed on November 2nd, after being pushed back a day for last minute revisions. However, despite the fact that the bill’s details are not yet publicly known there has already been a great deal of controversy and pushback against many suggested tax reform proposals.
Tax reform has gotten off to a rough start with construction and real estate industries.
Homebuilders have long been wary of current tax reform efforts, due to speculation about Republican interest in eliminating property tax deductions and reducing mortgage interest deductions. But in late September, the National Association of Home Builders announced that it was backing the plan for tax reform, apparently due to congressional assurances that a tax credit for property owners would offset the lost deductions.
But only a month later, the NAHB announced its opposition to the legislation after it learned that there would be no tax credit. It was also opposed to changes in the standard deduction that would further reduce the tax advantages of homeownership; an analysis by the Tax Policy Center found that the number of homeowners who would claim a home mortgage deduction would decrease from 21% to only 4%. Unsurprisingly, the NAHB characterized the proposed version of the bill as a “bad bill for the housing sector.”
With the wrath of the housing industry rising, lawmakers from states including California, New York and New Jersey announced their opposition to reducing property deductions. Facing rebellion from without and within, lawmakers finally capitulated at the end of October, and announced they would not reduce property tax reductions.
It is highly unlikely that this is the last controversy that the bill will face, and there will be many revisions before the bill sees a vote. This makes it very difficult to know exactly how tax reform will affect Socotra Capital’s clients and other real estate investors. However, the last few months of discussion about the tax reform bill have given us some clues as to what to expect. Below is an overview of how property investors could be affected. Some anticipated changes are positive, while others are not.
Keep in mind that each person’s tax situation is unique, and we strongly advise you to consult with a licensed tax specialist to get a better understanding of your options.
Reducing Number of Tax Brackets – Good for Property Investors
The current tax reform bill being considered by lawmakers would reduce the number of income tax brackets from seven to three, with tax rates on the three brackets being 12%, 25%, and 35%. There is an option for a fourth tax bracket for the wealthiest taxpayers, but details of this have not been announced.
Most of the income received by Socotra Capital investors is classified under ordinary income as taxable interest. By reducing the number of income tax brackets and setting the remaining brackets to the proposed rates, real estate investors would see more of their income taxed at reduced rates.
Eliminating the Alternative Minimum Tax (AMT) – Good for Property Investors
The alternative minimum tax is essentially a supplemental tax on higher income individuals who have significant deductions. Repealing the AMT would yield a significant benefit many higher income investors.
Increasing the Standard Deduction – Uncertain for Property Investors
When paying income taxes, individuals must choose whether they wish to use the standard deduction or instead itemize their deductions. Many of our clients significantly reduce their adjusted gross income (AGI) by itemizing their deductions.
AGI is the income that determines what tax bracket a taxpayer falls into, and the top tax rate they will pay. Taxpayers with a large number of itemized deductions realize a two-fold savings: a reduction of their gross income, and the opportunity to drop down into a lower tax bracket.
But one of the changes suggested by lawmakers—as mentioned above—is to increase the standard deduction. Depending on the individual, this is a mixed bag for investors. The value of itemized deductions would be reduced so that in some cases, homeowners and property investors would not see any tax benefit from their itemized deductions.
Eliminating the State Income Tax Deduction – Bad for Property Investors (In Some States)
One consideration on the table is eliminating the deduction for state income tax, though this has received some blowback from lawmakers who had opposed reducing mortgage interest deductions.
For property investors in states with no state income tax, this change would have no impact. But for property investors in states such as the above, they would lose a valuable deduction. In combination with the increase in the standard deduction, many would fall below the threshold for seeing a benefit from itemizing their deductions.
Reducing Tax-Deferred 401(k) Contributions – Bad for Property Investors
While the President has reassured the public as recently as late October that the tax bill would not impact 401(k) contributions, lawmakers have continued to consider reducing the annual cap on tax-deferred 401(k) contributions from $18,000 to $2,400.
This would increase the tax burden on just about all American taxpayers, and investors in particular. Many of our clients roll over their 401(k) accounts into IRAs, and then use that income to invest in our funds. Lowering the cap on tax-deferred 401(k) and IRA contributions would have an especially large impact on those clients.
There has also been speculation that lawmakers may move to strike “Stretch IRA” rules allowing non-spouse beneficiaries of 401(k)s and IRAs “stretch” the payout over their lifetimes. Instead, such accounts would have to be paid out in full within five years. This would have a significant negative impact on our clients’ beneficiaries.
The exact consequences of the tax bill—and whether it be passed—are not yet known.
Bear in mind that all of the above is based upon public disclosures by legislators, and the President, as well as lobbyists and associations that have had the opportunity to view preliminary versions of the tax bill. We do not know for certain what changes the bill will make to the current tax code, and how real estate investors will be impacted.
But you can be certain that when we do know, Socotra Capital will be there to help you maximize the returns on your property investments. To learn more about how Socotra Capital can help you realize a consistent, sizeable return on your investments, call us at 855-889-7626, or send us a message using our contact form.