President-elect Trump’s proposed tax plan could create new lending opportunities for mortgage pool funds. Assuming that the US House, Senate and White House implement the plan in its present form, changes to the tax code could free up more capital for business investment. “Pass through” investments such as mortgage pool funds could also benefit from some aspects of the new tax plan.
Effect on Mortgage Pool Fund Investors
Under the new plan, some mortgage pool fund investors could enjoy lower tax rates. Trump’s plan would condense the existing seven brackets for federal tax filers into just three brackets. For individuals with annual incomes less than $37,500, the federal tax rate would top out at 12 percent. Filers earnings at least $37,500 but less than $112,500 would be taxed at a 25 percent rate. Those with earning above $112,500 would pay the maximum tax rate of 33 percent. Joint filers would have the same tax brackets, but with rates based on income twice that of individual filers.
Trump’s tax brackets are much broader than the current federal tax plan. At present, individuals earning more than $37,650 but less than $91,150 are taxed at 25 percent Rates increase to 28 percent for those earnings between $91,150 and $190,150, 33 percent for those earnings between $190,150 and $413,350, 35 percent for those earnings between $413,350 and $415,050 and max out at 39.6 percent for incomes exceeding $415,050 annually.
Mortgage pool fund distributions are taxed as income rather than at the lower 15-20 percent dividend rate, so tax brackets can significantly affect fund investors. Most mortgage pool fund subscribers are in higher tax brackets due to the fact that funds are marketed primarily to “accredited investors”, defined as individuals having a net worth of at least $1 million and/or an annual income exceeding $200,000.
Under the Trump plan, an individual earning more than $415,050 per year and holding a $1.0 million investment in a mortgage pool fund yielding 8 percent would generate after-tax profits of $53,600 from this investment. The same investor realizes an after-tax profit of just $48,320 under the existing tax plan. However, investors earning less than $190,150 per year may see their after-tax return decline under the new guidelines as a result of moving from a 28 percent tax bracket to the new maximum bracket of 33 percent.
Those investors may benefit from other aspects of the Trump tax plan, which include boosting the standard deduction for individual filers from $6,300 to $15,000, capping the capital gains tax rate at 20 percent and eliminating the unpopular 3.8 percent “Obamacare” surtax on net investment income. This surtax mainly affects taxpayers with high adjusted gross income. Net investment income includes income from interest, dividends, rents, royalties, passive income and gains on sales of most properties.
Effect on Fix-and-Flip Businesses
Increasing the standard deduction could impact levels of home ownership. Strong housing demand is important to mortgage pool funds, which derive most of their income from fix-and-flip loans. There is some debate among economists on how increasing the standard deduction will impact home ownership. Some economists believe that a higher standard deduction will make itemized deductions less appealing. If fewer filers opt to write off mortgage interest and property taxes, the result could be lower levels of home ownership as more people choose renting over owning. To the extent that this argument is valid, Trump’s plan may cause some fix-and-flip businesses to alter their strategy from fix-and-flip to fix, hold and rent.
The biggest winners under the Trump tax plan are corporations, which could see their tax rates decline from 35 percent to 15 percent. The new plan also allows deductions to be taken up-front rather than over a multi-year period. President-elect Trump and his advisors believe that lowering corporate tax rates will boost GDP growth by freeing up capital that can be redeployed in new ventures, thus encouraging business activity and the creation of more jobs. Trump also wants LLCs, partnerships and S corporations to qualify for the new lower 15 percent tax rate. This could be a major boon for the fix-and-flip industry since many fix- and-flip businesses are organized as LLCs or partnerships. Tax savings realized by these businesses under the new tax code could lead to stepped-up investments in new properties. Mortgage pool funds may benefit from increased demand for hard money loans.
Another component of Trump’s tax plan is a fixed capital gains tax rate of 20 percent. At present, profits from property sales are taxed at two different rates, depending on how long the property was held. Selling real estate that was held for less than a year triggers a short-term capital gain, which is taxed as ordinary income. Selling property held for more than a year results in a long-term capital gain, which is taxed at 20 percent. By locking in a 20 percent tax rate for all property sales, Trump’s plan gives fix-and-flip businesses greater incentives to turn properties quickly. With a fixed tax rate, other considerations such as property maintenance costs take on added weight. Property investors would likely seek to minimize monthly maintenance costs by flipping properties quickly.
In general, President-elect Trump’s tax plan presents a mixed bag for real estate investors. On the one hand, the plan could boost the economy and positively impact household incomes and housing demand. Some fear that a higher standard deduction will make mortgage interest write-offs less popular and reduce incentives for home ownership. Mortgage pool fund investors may keep a larger share of their monthly distributions under the new tax brackets. Fix-and-flip businesses could benefit from having more capital to invest and these businesses would also have incentives to flip properties more quickly. This could result in greater demand for hard money loans and accelerated growth in mortgage pool fund assets and income. .