What REALTORS® Need to Know About the New Tax Law

This video series with Evan Liddiard, Director of Federal Tax Policy for the National Association of REALTORS®, and Peter Baker of the Business Planning Group, gives an overview of 2018's new tax laws. The series offers guidance for individuals and families filing tax returns, the tax incentives of owning a home, as well as business tax changes for real estate professionals. 

1: An Introduction to the Tax Cuts and Jobs Act of 2017

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EML: (lower third - Evan M. Liddiard, CPA (first line) Director of Federal Tax Policy, National Association of REALTORS® (second line)

My name is Evan Liddiard of the National Association of REALTORS®. We want to welcome you to our video series on what you need to know about the new tax law. In this short segment, we will give a brief overview of the new law and then tell you what you can expect to learn by watching this series of four videos.

Assisting me through the series is my friend Peter Baker of the Business Planning Group. Peter is a seasoned accountant who has decades of experience helping REALTORS® and real estate businesses with their taxes. Welcome, Peter, and thanks for joining us.

PB: (lower third - Peter G. Baker, CPA (first line) Founder of Business Planning Group, Washington, DC (second line)

I am very happy to be here, Evan.

Some of our viewers might be wondering, why are we releasing this series of videos now? After all, the new tax law was passed into law back in December of 2017. Shouldn't this information have been provided to us months ago?

EML:

The answer is yes. And it was provided. NAR.realtor has included many articles and summaries of the tax law, going back to before it was passed by Congress.

However, there are a couple of good reasons why we are bringing this information to you now in this format. First, REALTORS® are very busy people, and as with most Americans, many of you have not had the time to focus on the new tax law in a systematic way.

And now that the end of 2018 is just around the corner, it is a good time to provide concise yet comprehensive information that you need to know about how the tax rules have changed for you.

Second, these tax law changes were developed and enacted very quickly last year. Because of this, many of the details were left to be filled in by regulations. And these detailed rules are just now beginning to appear. We can now tell you much more about how the new law will affect you than we could have just three months ago.

Peter, now that we are past the final deadline for filing 2017 tax returns, are you finding that your real estate clients are now turning their attention to next year?

PB:

Yes. 2019 will be here before we know it, and I am seeing a big interest among my clients in wanting to know what changes this new tax law has brought us.

EML:

There is a great deal that could be said about the new tax law and how it was developed. It is a fascinating story of politics, power, and political process.

But this video series is focused on the essentials, so we are going to get right into the heart of the adjustments and how they affect you.

However, it is important that you are aware of three driving forces underlying the development of the tax act, as knowing them should help make sense of some of the "why" questions that might come up.

The first driving force was the desire on the part of the architects of the act to cut taxes for most businesses and individuals. And thanks to the $1.5 trillion that will be added to the national debt over the next ten years, about 80% of tax filers will receive a tax cut averaging about $2,100 per year, while about 5% will face an average tax increase of about $2,800. The other 15% will see no changes.

The second driver was the hope to simplify tax filing for most people. People could argue about this issue for a long time, but I think it is fair to say that tax returns will be a little simpler for most people as a result of these changes. Would you agree with this, Peter?

PB:

Yes. Millions of people will no longer be itemizing their deductions, and this will make filing their taxes somewhat easier and faster. However, the flip-side of this is that some of the traditional incentives in the tax law, such as for owning a home or making charitable contributions, due to the increased standard deduction, will no longer be utilized or be the specific benefit that they were in prior years , or will be weaker, for those same millions of people.

Most people, and certainly most of your membership though, will not see a drastic amount of simplification to their tax lives as a result of the new tax law. In fact, in several important ways, the rules have gotten more complicated.

EML:

The final driving force, which really increased the difficulty of passing the bill, was the congressional budget process that was used to push the legislation through Congress. Partly because of that process, the bill was delayed for much of last year, and then it moved through very quickly. This meant that the changes were rushed and some drafting errors were made. And more of the details were left to the discretion of the Treasury Department and IRS.

PB:

The Tax Cuts and Jobs Act was the biggest modification to the tax law in more than 30 years. There are hundreds of provisions in dozens of different areas of the tax code. Fortunately, not all of these changes will affect real estate and those who make their living in this industry.

EML:

Let us finish our introduction by giving a short overview of what the rest of the series covers. The next video, #2, delves into the major modifications facing individuals and families filing tax returns. It explains the changes in the tax rates, the standard deduction, and personal and dependency exemptions, and the tax credit for children.

Here, everyone who files a tax return will find that the basic concepts of how individuals are taxed in America are now different. And while many of these changes are in the favor of the tax filer, some go in the opposite direction.

PB:

Video #3 will explain what happened to the tax deductions that affect owing and buying a home, such as the mortgage interest and the state and local tax deductions. We will also cover some surprising modifications to the moving expense and casualty loss deductions.

EML:

The last video in our series than delves into what is now different with the way you are taxed as a real estate professional. In it, we will explain what happened to the meals and entertainment deduction, which is a little bit of bad news.

And we will also acquaint you with a brand-new deduction for those who are in business for themselves as an independent contract or owner of a pass-through business, such as an S corporation, limited liability company, or partnership.

The news here for most REALTORS® will be very good, as you are probably eligible for a significant tax deduction you may not even know about yet.

PB:

So once again, we thank you for joining us, and we look forward to sharing what you need to know about the new tax law.



2: Major Changes Affecting Individuals

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EML: (lower third - Evan M. Liddiard, CPA (first line) Director of Federal Tax Policy, National Association of REALTORS® (second line)

My name is Evan Liddiard of the National Association of REALTORS® and I would like to welcome you to our video series on what you need to know about the new tax law. In this segment, we are going to cover some of the major changes facing individuals and families filing tax returns for 2018.

Joining me is Peter Baker of the Business Planning Group. Peter has decades of experience helping REALTORS® and real estate businesses with their taxes.

PB: (lower third - Peter G. Baker, CPA (first line) Founder of Business Planning Group, Washington, DC (second line)

Glad to be here, Evan.

EML:

Let's start out by discussing the individual tax rates and how they're different. Most of you have probably heard by now that in general, the tax rates and brackets went down significantly from 2017. But does this mean that everyone is going to get a tax cut? The answer, unfortunately, is no.

But unlike most pure tax reform bills, this one was also a net tax cut, meaning that not all of the reductions in revenue to Uncle Sam were offset by tax increases on other taxpayers. So it is not a zero sum game. This means that a high percentage of tax filers will either get a tax cut or pay the same as before. But about 5 to 10 percent will be paying more under these changes.

PB:

Yes, as I speak with my Realtor clients about the changes brought about tax reform, many are initially skeptical that they are going to come out ahead. But in most cases, when we look closely at their situations, many will result in a net tax cut.

EML:

Peter, let me home in on that word "net." This is because the new law is going to lower taxes in some ways and raise it in others, and what that net number will be is going to depend on your individual circumstances.

[suggested graphic - stylized IRS tax rate table or tax brackets]

Let's start out by taking a close look at the tax rates. This is an area where the news is all good because every one of the rates or brackets went down from 2017 to 2018.

 

[show slide 1 - income tax rate comparison]

Let's look at the tax rates between last year and this year for single people at three different levels of income. The numbers will be somewhat different for married couples filing a joint return or for single heads of household, but the amount of reduction in taxes due to the rate cuts will be similar across the board.

Let's first consider a real estate agent with taxable income of $75,000. If he or she had earned this amount in 2017, they would have a tax bill of just under $14,500. This would be an average rate of just over 19 percent, and they would be in the 25 percent marginal tax bracket, meaning that each additional dollar earned at this income level would be taxed at 25 cents.

But for 2018, that same agent earning that same amount would pay only $12,440 in tax. This is an average rate of 16.6 percent and a marginal rate of just 22 percent. So, if all other things were equal (which they are not, as we will soon discuss), this Realtor would be saving well over $2,000 in taxes because of the new tax law.

Now, let's suppose that the income level were doubled to $150,000. For 2017, the agent would have a tax due of nearly $35,000, which is way more than twice as much tax than at $75,000. This is because our tax rates are still progressive, meaning that the higher the income the higher the tax rate. In this case, the average tax rate is 23.3 percent and the marginal rate rises to 28 percent, meaning that of every extra dollar earned, the filer must now pay 28 cents.

But let's consider what happens for 2018 with this income level. Here the tax is $30,290, which represents just 20.2 percent on average. And this is because the marginal rate is 24 percent, compared with 28 percent under the old law. The bottom line is that the rate changes save this Realtor over $4,700 in just one year. Not bad at all. But again, this ignores other changes that we will soon discuss.

Finally, let's take a look at someone who is doing really well with taxable income of $450,000. In 2017 he or she would have been in the highest tax bracket of 39.6 percent, and their tax would have been just over $134,000. This is an average rate of almost 30 percent.

But in this case, the new tax law doesn't save him or her all that much. It is true that the marginal tax rate drops down to 35 percent, but because of the way the brackets are structured, this person is only going to save about $800.

However, this is just an anomaly. If we were to look at someone making $600,000, they would save over $5,700. Someone making over $800K would save over $11,000, and a million-dollar earner would bank over $16,000 in savings from these rate changes alone. Peter, what do you think about this?

PB:

None of my clients can complain about this rate& bracket aspect of the new tax law, this area alone highlights the importance of advance tax planning. This one change saves every income tax payer money, and if this were all there was to the changes, everyone would be pretty happy and we could turn off the camera now. But, as you know, things are hardly ever that simple.

EML:

Let's now turn to two of these other changes that happen to go in opposite directions from each other. In other words, one of these changes tends to lower the tax owed for the majority of filers, but certainly not everyone, and the other will cause almost everyone to have to pay more. I call them dueling tax changes because they will be fighting it out in most tax returns to see who wins.

[show slide 2 - dueling tax changes]

The concepts here are just a bit more involved and will take a little background explanation. The first change, which will be a positive one for most tax filers, is that the new tax law almost doubled the standard deduction. Peter, would you take a couple of minutes and give some background on the standard deduction?

PB:

Historically, more than two-thirds of all tax filers have claimed the standard deduction instead of itemizing their deductions. The way this deduction works is "greater of" calculation; everyone is given a set amount of assumed deductions (known as Standard Deduction), alternatively, you have actual deductions which can be itemized, such as mortgage interest and charitable contributions, and additional activity as gathered on Sch. A of the 1040; if actual deductions are greater than the standard, this is the amount you claim.

To illustrate under the old law (2017), the amount of this standard deduction was $6,500 for single filers and twice that amount for married couples, or $13,000. So, if a married couple had mortgage interest totaling $10,000 and also gave $5,000 to charity, they would have $15,000 in total deductions, so in this example they would itemize because that would result in greater deductions over the standard, lowering their tax bill. In this manner, approximately a third of all tax filers would itemize their deduction.

But if that same couple had donated only $2,000, their itemized total would be just $12,000, which of course is below the old standard amount of $13,000. In this case the married couple would claim the greater standard deduction to lower their tax bill.

In contrast, today's new tax law nearly doubles these standard deduction amounts to $12,000 for singles and $24,000 for couples. And for obvious reasons, this really shakes the planning process up when it comes to the incentive effect and timing of tax deductions. We will talk more about this in a later segment.

So for a moment, to think about those two-thirds of filers who have been using the Standard Deduction. If you are a single tax filer who usually has only $2,500 in actual deductions, let's say it is for state income taxes, then, under the old law, you would always be claiming the $6,500 standard deduction. The tax system was giving you an extra $4,000 in deductions not actually incurred.

But now, with a new standard deduction of $12,000 for singles, the new tax law is giving you an extra $9,500 in tax deductions not actually spent. Therefore, for taxpayers whose actual deductions have been lower than the standard amount, this change is an additional tax cut.

EML:

But not everyone will find this to be a benefit. Remember that Peter said about two-thirds of filers claimed the standard deduction under the old rules. For the other one-third of filers, the ones who had more deductions than the standard amount, some will also get a benefit to the extent that their actual deductions are still less than the new higher standard deduction.

But those with itemized deductions higher than the $12,000 or $24,000 amounts will not receive any extra tax benefit from this change. The congressional Joint Committee on Taxation estimates that this will be only about 10 to 12 percent of all tax filers.

So, to sum up this part, this first change is another big plus to most people, but not for all. Those who still itemize will not get any tax reduction benefit from this change.

But remember I said there were two big changes in this section. The first one we just discussed is positive to most people but not all. But the second one is a negative for everyone.

Most of you will recognize that the tax law has long provided some big exemptions for you, for your spouse if you have one, and for each dependent in your family. These are called the personal and dependency exemptions. Under the old rules each exemption was worth $4,150. In other words, you could generally deduct this much from your income for yourself, for a spouse, and for any dependents you could claim.

The big change is that these personal and dependency exemptions have been repealed. This is a major change and one that many people are still not aware happened.

[show slide 3 - standard deduction bait and switch]

Many tax filers heard plenty about the positive changes that reduced their taxes through lowering the rates and increasing the standard deduction. But not too much was said about the loss of the personal and dependency exemptions. Thus, what might seem like a great deal all around was not such a bargain, at least not for everyone.

For example, if you are a single filer, you still came out a clear winner under this analysis. If you add up the prior law's standard deduction of $6,500 and the personal exemption you get for yourself, you would have a total amount of $10,650 of your income exempted from tax. Now, under the new law, with a total standard deduction of $12,000, you still come out ahead by $1,350. This alone is worth almost $300 in tax savings.

However, what if you are a family of five? Under the old law, you and your spouse received not only a standard deduction of $13,000, but also additional exemptions totaling $4,150 for each of the five members of the family. This gave you a total untaxed amount of nearly $34,000 under the old law.

Compare that with a relatively measly $24,000 from the higher standard deduction. Here is a shortfall over more than $10,000 of deduction or exemption. Again, if this family were in the 22 percent tax bracket, this would mean a tax increase of over $2,100.

But wait. There is more to this story - at least for tax filers with young children.

The new tax law doubles the tax credit for children, and makes it much more accessible to those with higher incomes. Thus, most tax filers with children under the age of 17 will find that this change will more than compensate for the loss of the dependency exemptions. Let me turn it over to Peter.

PB:

Historically, for tax filers with young (under 17) children, the child credit has been a meaningful benefit IF you met the income and other restrictions. The benefit started out as a $500 credit back in the late 90s (1997), and then, in 2001, it was increased to $1,000 per child but subject to income limits.

The value of the credit was fully phased out once adjusted gross income reached

1. $95,000 for singles and

2. $130,000 for married couples.

The new tax law doubled the tax credit to $2,000 per child, and also significantly increased the income level where the credit is fully phased out to

1. $240,000 for single filers and

2. $440,000 for married couples.

As a result, the child tax credit is going to be a much greater benefit for even more people.

And remember, a tax credit is much more valuable than is a tax deduction. A deduction only lowers the amount of income that is subject to tax, while a credit is a dollar-for-dollar offset against the tax ultimately due.

 
 

EML:

We hope it is becoming obvious that there are many moving pieces to this tax law, and while most people will get a tax cut, the amount will vary by a great deal, and some will even have to pay more.

I would like to drive this home by showing you how your family circumstances can shape how you fare.

[show slide 4 - doubled child credit]

Let's first assume the case of Andrea Agent, who lives with her young son, making her eligible for head of household filing status. She makes $100,000 per year and this tax law is good to Andrea. In total, she will be enjoying a tax cut of almost $4,600.

Every change we talked about so far is helpful to Ms. Agent. The increase in the standard deduction will lower her taxes, and so will the lower tax rate, where much of her income will be taxed at the 22 percent rate instead of 25 percent rate.

But it is the increased child credit, and especially the fact that the income cutoff has been raised, that delivers the $2,000 cherry on top, as Andrea was not able to claim this credit at all last year, since she made over last year's income limit.

Now, let's look at Bill and Beverly Broker, a married couple with three young children. The Broker Family brings in $175,000 per year, and they are also treated very well by the tax law. Compared with last year, Bill and Bev will see a tax cut of almost $7,700 each year.

As with Andrea above, the Brokers enjoy the benefit of the lower tax rate, which fully overcomes the loss of the personal and dependency exemptions. But by far the biggest benefit for them is the doubled child tax credit, for which they are now eligible now that the income phase-out level has gone up.

But it's a different story for Randy and Rebecca Realtor, who are also married with three children. This family earns $125,000 per year, just $50,000 less than does the Broker Family. But unlike Bill and Beverly, however, Randy and Rebecca's three kids are all over the age of 16, even though they are still dependents. Therefore, they do not qualify for the child tax credit. And while they still get a tax cut, it is miniscule compared with what the other families receive.

PB:

This shows the impact of the changes will depend on your own family situation. I have talked with impacted clients about this new law already, and there have been a lot of surprises, some good, some not quite as good, but that is the tax planning process in motion.

EML:

This concludes this section of our video series. In the next one, we are going to talk about the big changes the new tax bill offers for the tax incentives of owning a home, and especially for the deductions for mortgage interest deduction and for state and local taxes. Thanks for watching



3: Changes Affecting Tax Incentives of Owning a Home

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EML: (lower third - Evan M. Liddiard, CPA (first line) Director of Federal Tax Policy, National Association of REALTORS® (second line)

My name is Evan Liddiard of the National Association of REALTORS® and I would like to welcome you to our video series on what you need to know about the new tax law. In this segment, we are going to cover the changes affecting the tax incentives of owning a home for individuals and families filing tax returns for 2018.

Joining me is Peter Baker of the Business Planning Group. Peter has decades of experience helping REALTORS® and real estate businesses with their taxes.

PB: (lower third - Peter G. Baker, CPA (first line) Founder of Business Planning Group, Washington, DC (second line)

Happy to be back, Evan.

EML:

In the prior video, we talked about the good news for most American tax filers that comes from the fact that last year's Tax Cuts and Jobs Act significantly lowered the income tax rates. We also mentioned the mixed news that the standard deduction has nearly doubled but that the personal and dependency exemptions have gone away.

However, for those with kids age 16 and under, the child credit has been doubled to $2,000, with higher-income families able to claim it. Overall, the net effect of these changes is very positive for most individuals and families.

In this segment, though, we are going to cover some changes that are not as welcome, because they repealed tax benefits that millions have relied on, in some cases, for decades. Most of these changes relate to owning a home.

 

PB:

For more than 100 years, since the modern income tax system was created in 1913, the law has incentivized Americans to purchase a home by allowing a deduction for mortgage interest paid when you borrow to buy a home, and also by allowing an unlimited deduction for property taxes paid on that home.

The tax law still allows these homeownership deductions, but starting in 2018, there are some new restrictions on both the mortgage interest and the property tax that will impact some homeowners.

These changes will affect people in different ways - some will find them a big problem, while many, partly due to the increased standard deduction, won't notice them at all.

[Slide 1 - Changes to the Mortgage Interest Deduction]

EML:

We will begin by covering the changes to the mortgage interest deduction. These can be confusing but our goal is to bring you clarity.

Since 1987, there has been a $1 million limit on the amount of mortgage debt that could be borrowed for purposes of having the interest be deductible. For example, if someone borrowed $1.3 million on a mortgage to buy a home, only the interest on the first $1 million was deductible.

The new tax law has now lowered that $1 million limit to $750,000, but only for new mortgages taken out after December 14, 2017. For mortgage loans existing on that date, the limit is still $1 million.

And interest on these "grandfathered" mortgages will remain deductible as long as the homeowner keeps the loan. Such loans can even be refinanced with the deduction retained, so long as the original term of the loan and the balance owed on the date of refinancing is not increased.

PB:

There is also some good news on the interest deduction for second homes. The House version of the tax reform bill removed the deduction for second homes altogether. But the final tax act keeps it intact.

However, for new loans after December 14, 2017, the total amount borrowed for both the main residence and the second home cannot exceed $750,000. Grandfathered loans that existed on that date, however, are still deductible up to $1 million for both the main home and the second home combined.

EML:

We have one final change to discuss on deducting mortgage interest. There has been a great deal of confusion about whether interest on home equity loans, home equity lines of credit, or second mortgages can be deducted. The new law now prohibits the deduction of such interest, but only if the proceeds of the loan are used for personal purposes, such vacations, cars, higher education expenses, or paying off other debt.

However, if the money from such a loan is or was used to pay for substantial improvements on the home against which the money was borrowed, then the interest remains deductible. The same $750,000 total limits apply for new home equity loans taken out after last December 14.

If you have a home equity or second mortgage loan that was in existence on December 14, the limit is still $1 million, but all your loans, first, second, and/or home equity, have to be under these limits. And remember, the proceeds of all loans had to be used to purchase, construct, or substantially improve the home in order for the interest to be deductible.

Peter, how big a deal are these changes going to be for your clients here in the Washington, DC area?

PB:

For most of my clients, who are not selling their home or buying another one right now, there won't be much impact at all due to the grandfathering feature for existing loans.

However, if any taxpayers want to purchase a second home or move up to a larger home, this new $750,000 cap can be a limiting factor. Washington is a high-cost area for homes, and many residents have homes worth much more than this cap. In other parts of the U.S., though, the lower mortgage ceiling will affect very few people because houses, on average, in those areas are worth far less than the limit.

Lastly, in cases where home equity loans are used for personal purposes, and not to fix up their home; not being able to deduct this interest has a negative impact to their tax and spending plan and is an effective increase to the cost of borrowing.

 

[Slide 2 - Changes to the SALT Deduction]

EML:

The next big item to discuss for homeowners is the new limit on the deduction for state and local taxes, which is often referred to as SALT. This change has received a lot of attention and it has been very controversial. One of the biggest expenses facing homeowners is the property tax they must pay, and up until this year, this and all other state and local taxes have been deductible without limit for itemizers.

Starting in 2018, however, every individual and family faces a maximum deduction for all of their state and local taxes of $10,000. Please note that single individuals and married people face the same $10,000 limit, which means that this provision brings a nasty marriage penalty into the picture.

The $10,000 limit is for the total of all state and local taxes. For those living in states that have an income tax, which is all but seven, this means that total deduction for property and income tax for the single filer or the family cannot exceed $10,000. Those in states without an income tax are allowed to deduct sales tax instead, so this is what would be added to property taxes to determine the total.

PB:

As is the case with the lower cap on mortgages, this new $10,000 SALT limit is not going to be a big problem everywhere. In many parts of the nation, property and income taxes are relatively low, and even two-earner couples will not be shelling out more than $10 grand in total in state and local taxes.

The $10,000 limit is not indexed for inflation, however, and over time, its impact will grow as state taxes naturally rise due to the higher home values and higher costs of living.

EML:

There are many places, particularly on the coasts and in the Northeast and some in the Great Lakes area, where a very high percentage of homeowners are going to find their state and local tax deduction limited. In a handful of these states, the property tax on a median valued home by itself takes up more than half of the limit, before income taxes are even considered.

Also, please note that there will be at least some people in every state who will feel the pinch of this limit on the SALT deduction. Of course, those with higher-valued homes and who also earn a lot of income will be hit the hardest.

As bad as this new limit might be, it might have been far worse. The original bill in the House had a $10,000 limit on property taxes but did not allow any income tax to be deductible. And the first Senate bill disallowed the state and local tax deduction altogether.

PB:

Evan, I think we should emphasize here that neither the new SALT cap of $10,000, nor the new limit on the mortgage interest deduction, affect landlords of rental property. Interest expense and property taxes on such rental real estate as well as other trade or businesses will continue to be fully deductible to the owners. So in this sense, the tax code pendulum has shifted between homeowners versus renters.

EML:

Now, let's spend a couple of minutes talking about a few other changes that will not affect as many homeowners as the ones we just covered, but that still could really take a tax bite out of those who are hit by them.

[Slide 3 - Other Changes]

The first one of these is the curtailment of the casualty loss deduction. This provision has been in the tax law for a long time and was designed to assist those who found themselves victims to losses due to fire, storm, theft, or other sudden and expected events that cost them money.

Under the prior law, someone who suffered a casualty loss could take an itemized deduction for the portion of the loss that exceeded any insurance proceeds and to the extent that the loss was greater than 10 percent of their income. This could make a tremendous difference for those with large losses or low incomes or both.

But last year's tax bill repealed the casualty loss deduction with one major exception - it is still available for those who suffer casualty losses attributable to a presidentially-declared disaster.

Peter, how big of a change is this?

PB:

Of course, most of us who are lucky enough to not experience a casualty loss will not even miss this deduction. But unfortunately, those who have a fire or other loss occur which happens to not be the result of a widespread disaster, could now be doubly unlucky by the repeal of this deduction.

Also, under the old law, because this casualty loss deduction was designed to help those most with the largest losses and/or the lowest incomes, these are the people who will be most hurt if their casualty happens outside a disaster zone.

 

EML:

The second noteworthy change in this section is the almost complete repeal of the moving expense deduction. Many clients of REALTORS® are among the tens of millions of Americans who move each year.

Under the previous tax law, many of the expenses of moving were deductible if the new place of work was at least 50 miles farther from the former home than was the former workplace. If this test were met, the reasonable expenses of moving household goods and personal effects from the old to the new residence was deductible, along with the cost of traveling.

The new law repealed this deduction for everyone except members of the Armed Forces on active duty that move pursuant to a military order incident to a permanent change of duty station.

PB:

Losing this deduction is going to be tough on a lot of people. But it is even going to be worse than it might seem for many of them. This is because this deduction is not just for itemizers. Rather, it is known as an above-the-line deduction, meaning that everyone can take it whether they itemize or not.

This is key because in many cases, the employer reimburses the employee for these expenses when they are job-related. And the dollars involved can be quite large, especially for longer distance moves and when there is a family. But as you may or may not know, these reimbursed amounts are often included in the employee's Form W-2 as taxable income.

When, under the old law, the employee is able to claim the moving expense deduction, the income and deduction often result in a wash with no additional tax. But this will no longer be true.

Instead, employers who reimburse their workers for moves will have to either leave the employee responsible for the increased tax on move allowance, or will have to provide extra cash for them to pay the tax on the reimbursement amount, and possible gross that amount up to cover tax on the extra cash to pay the tax. And so on.

 

[Slide 20 - Exclusion of Gain on Sale of Principal Residence]

EML:

Finally, let us end this section on a high note. When the original versions of the tax reform bill were passed, they both included a provision that would have greatly limited the availability of the beloved tax provision that allows single sellers of a principal residence to exclude from tax up to $250,000 in capital gain on the sale of a home, and up to $500,000 for a joint return.

The provision said that instead of a seller being eligible for the exclusion after owning and living in the home for 2 of the prior 5 years, it would now be 5 of the prior 8 years. NAR research indicates that this change could affect as many as 20% of home owners.

Fortunately, with some strong lobbying by NAR and other groups, this change was eliminated and the final bill kept the prior 2-out-of-5-year rule for exempting the capital gain on the sale of a home. This was a huge win for REALTORS® and for homeowners.

PB:

It is great to see that at least one of the major tax incentives for owning a home came out of this new tax act unscathed.

EML:

This concludes this section of our video series. In the next one, we are going to discuss how the new tax law treats the business of being a real estate professional. And here we will have a big surprise for many of you - a brand-new deduction that can make a serious dent in your tax bill. Thanks for watching.



4: Tax Changes for the Real Estate Professional

Segments

Transcript and Slideshow

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EML: (lower third - Evan M. Liddiard, CPA (first line) Director of Federal Tax Policy, National Association of REALTORS® (second line)

My name is Evan Liddiard of the National Association of REALTORS®. Welcome back to our video series on what you need to know about the new tax law. In this segment, we will explore a couple of business tax changes for those who are self-employed. These apply to a high percentage of those who make their living helping people buy and sell real estate.

Joining me again is Peter Baker of the Business Planning Group. Peter has decades of experience helping REALTORS® and real estate businesses with their taxes.

PB: (lower third - Peter G. Baker, CPA (first line) Founder of Business Planning Group, Washington, DC (second line)

Great to be back, Evan.

EML:

Today we have just two provisions to go over, and they contrast with each other. The first is a new and pretty significant tax deduction for most of you, while the second is a small and annoying repeal of an old partial tax deduction. So, one is big and welcome news. The other is bad news but is much smaller in importance.

You may have heard a little bit about both of these changes, but perhaps you do not know how or if they apply to your own situation.

Peter, it's like the old saying, we have some good news and some not so good news - which do you want first?

PB:

Let's start with the bad news, Evan, then we can end this video on a very positive note.

EML:

Good thinking, Peter. Our first provision is a cutback in the deduction for business entertainment expenses. This is something on which many REALTORS® spend at least some money every year.

[Slide 1 - Deduction for Meals and Entertainment]

Up through the end of 2017, if a self-employed real estate professional took a business contact out to a ballgame or other entertainment event that either preceded or followed a business discussion, then 50% of the cost of the entertainment was deductible as a business expense. A similar rule also applied for a meal where business was discussed - 50% of the cost was deductible.

However, the new tax act changed this by repealing the 50% deduction for all entertainment expenses, even if they are related to a business discussion. This was effective as of January 1, 2018. Fortunately, the 50% deduction for business meals was retained.

Peter, this sounds pretty straightforward. How big of a change is this and is there anything else our viewers need to know?

PB:

As you said, Evan, for most taxpayers, this is more of an annoyance than a big dollar item. Yes, many REALTORS® will have slightly lower deductions, and that is never good, but maybe just as irritating is the fact that this is just one more change, one more bookkeeping entry, to have to deal with.

Until recently, there were some unanswered questions about how this change was really going to affect business people.

For example, suppose an agent named Randi Realtor were to take her business contacts Bob and Bev to a baseball game. She not only paid for the tickets but also buys hot dogs, soft drinks, and ice cream for all three while watching the game. How is this going to be treated - as a meal, which is still partially deductible, or as entertainment, which is now non-deductible?

In early October, the IRS released temporary guidance, which tax filers can rely on until the final rules come out, likely later this year.

The guidance makes clear that in cases where both food and entertainment is present, the cost of the food is still 50% deductible if it is purchased separately, or if the cost of the food is set out as a separate line item. So, in the case of Randi, the cost of the tickets is not deductible. However, since she paid for the food separately, she can deduct 50% of the food cost.

EML:

What if Randi took her guests to one of those nice stadium suites, where food is available? Doesn't part of Randi's cost represent the food?

PB:

Yes, but unless the cost of the food is set out as a separate line item, then all the cost will be allocated to entertainment and none of it will be deductible.

EML:

One situation I hear about from NAR members is when a Realtor hosts a reception for clients and potential clients and offers food. This is not exactly a business meal and it isn't really entertainment either. Peter, how do you think the temporary guidance applies to this situation?

PB:

Although the new guidance does not specifically say so, I would advise my clients to plan to take a 50% deduction for any food they purchase for business meetings or receptions like this, or for open houses where they host potential clients.

EML:

Well, that was not so painful, was it? And now we can move on to the good news, which is much bigger.

What is this new deduction I mentioned? It goes by several different names but probably the easiest is the "Deduction for Qualified Business Income." But you also might have heard it called the "Pass-Through Business Deduction" or the "199A Deduction," which refers to the section where it is found in the Internal Revenue Code.

[Slide 2 - Deduction for Qualified Business Income]

PB:

This is a deduction of up to 20% of certain business income of sole proprietors of businesses, such as independent contractors, and for owners of so-called pass-through businesses.

I think understanding the deduction might be a little easier if we first talk a bit about why it was included in the new tax law.

[Slide 3 - Centerpiece of New Tax Law]

EML:

As tax reform bill was being developed in Congress last year, there were many ideas that were discussed as being key parts. But the most essential element and centerpiece was a huge reduction in the corporate tax rate - a drop from 35% all the way down to 21%.

Making such a big change has lots of implications, both in and out of the corporate world. Not all business activity takes place within regular corporations. Indeed, more than 90% of all of America's business entities are not regular corporations. Instead, they are organized as partnerships, limited liability companies (LLCs), S corporations, or most common of all, just plain old sole proprietorships.

These businesses have one thing in common, and that is they report their income on their owners' individual tax returns. In fact, these businesses do not directly pay taxes at all. Instead, the tax liability is passed through to the owners.

There were two big concerns about drastically cutting the tax rate only for regular corporations. The first was political - what kind of signal to Main Street America would be sent if the new law only cut taxes for the big boys, but not for the millions of smaller businesses? This is not a good way to win friends if you are interested in reelection.

PB:

The second problem was more practical. What was to stop all these millions of small businesses from changing their status by incorporating to take advantage of these lower tax rates?

Thus, the architects of the tax bill knew that if they were going to include a big tax rate cut for corporations, they had to also put in a similar tax cut for these pass-through businesses too.

But this was a real problem, because unless there are certain safeguards in place, what is there to stop regular wage and salary earners from simply becoming independent contractors rather than employees and cutting themselves in on the action?

EML:

In the end, the provision that survived was a big surprise for most of us - a 20% deduction from net business income. This was much higher than was featured in earlier versions. And another surprise was that the deduction was available to all kinds of services businesses with incomes below certain thresholds.

[Slide 4 - Basics of Deduction for Qualified Business Income]

PB:

So, let's get into some details. This can be confusing because it is a brand-new concept.

It is important to note that the new deduction is not an itemized deduction. Nor is it a typical business deduction that is based on an expenditure. Rather, it is an across-the-board deduction from net income that is computed after other expenses have been factored in.

[Slide 5 - List of Specified Service Businesses]

EML:

The next thing to know is that the general rule of the new provision limits the deduction to non-specified service businesses. Well, what are these? This is tax law parlance for businesses in the following fields:

"any trade or business involving the performance of services in the fields of health, law, accounting, actuarial science, performing arts, consulting, athletics, financial services, brokerage services, investing or investment managing, trading, dealing in certain assets, or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees."

[Switch back to Slide 4]

You may be thinking that most real estate professionals are going to be classified in the definition of a specified service business. And this is what was expected.

But there is lots of good news here. And it has gotten even better with the recent release of guidance from Treasury and IRS. Peter, what is the first bit of good news?

PB:

A major exception was added right before the bill was enacted that allows almost any pass-through business owner with less than a certain amount of taxable income to still take the deduction, despite their being in one of these specified service businesses (SSB).

The exception provides that if the business owner has taxable income of less than $157,500 as a single taxpayer, or $315,000 as a married couple filing a joint return, then the restriction does not apply.

In other words, everyone who has qualified business income will be able to take the deduction, so long as their taxable income is below these thresholds.

And for those with income above these amounts, there is still hope. There are phase-in ranges of $50,000 for singles and $100,000 for joint returns. Over these ranges, the deduction is ratably phased out. If this sounds confusing, you are in good company. But we are going to cover some examples in a few moments that should help clarify.

[Slide 5 - Specified Service Businesses]

EML:

Now, for the second bit of good news. Take another look at this list of service business fields, which are prohibited from claiming the 20% deduction if their income is over the thresholds.

When preliminary guidance came out in, it specifically said that real estate is not included in the term "brokerage services." Instead, this term was limited to the brokerage of stocks and other securities.

This big win for the real estate was at least partly the result of a huge effort by NAR in urging Treasury and IRS to remove real estate from the list.

To sum up, the first exception allows all real estate professionals with income below the thresholds to claim the 20% deduction. And the recent guidance says that even real estate agents and brokers with incomeabove the thresholds will be eligible for a deduction of up to 20%, according to a formula.

[Slide 6 - 2nd Set of Exceptions for Non-Specified Service Business Income]

PB:

This formula provides that the 20% deduction is available, but is limited to the greater of:

1) 50% of the W-2 wages paid by the business, or

2) the total of 25% of the W-2 wages paid by the business plus 2.5% of the original cost basis of the tangible depreciable property of the business at the end of the year.

Confusing, right? Hopefully you can see that in order to get a deduction if you are over the taxable income thresholds, to qualify for any deduction your business will need to either pay (W-2) wages to employees, or own depreciable property, or both.

It might be best if we try to explain this using some examples.

[Slide 7 - Amy Agent]

EML:

In this first example, we are looking at a fairly average Realtor named Amy Agent. She has net commissions of $67,000 for the year, after deducting all of her normal business expenses.

The first thing to notice is that unlike under the prior law, Amy is eligible for a 20% deduction of $11,000. This makes a big difference. We discussed the changes in the personal exemption and the standard deduction in earlier segments and you can see their impact here as well.

The bottom line for Amy is that she gets a tax cut compared with the prior law of over $4,200. And more than half of it, $2,420, is attributable to the new 20% deduction.

PB:

But, if Amy had earned commission income greater than the threshold amount of $157,500, a partial deduction may be available.

[Slide 8 - David Developer]

EML:

Our last example shows what happens when someone has income far above the threshold. David Developer owns an S corporation and he pays himself $80,000 in salary from the business. But the company also earns $370,000 in net income, which is passed through to David on his own tax return.

As you can see, David and his spouse are right at the phase-out level of $415,000. But because his income does not come from one of the specified businesses where higher income is not eligible for the deduction, we can look to the formula to see how much deduction he gets.

David's salary of $80,000 is one factor, which provides the deduction can be no higher than 50% of the salary paid by the company. This would be $40,000. But the second limiting factor would give him a higher deduction. This one says that the total of 25% of the salary paid, which would be $20,000, plus 2.5% of the original cost of depreciable property owned by the business.

In this example, we assume that David has a building that is worth $1.8 million, not counting the land. 2.5% of this amount is $45,000. Add this to the $20,000 and we get a deduction of $65,000. This is a big number but it is still smaller than the full 20% of his net business income, which is $74,000.

The bottom line tax saving for David compared with the prior law is over $38,000, of which more than $21,000 comes from the new deduction and the rest is from lower tax rates and other changes.

PB:

These new changes really are revolutionary for owners of pass-through businesses and the self-employed. My clients are very excited about these changes but they are also quite confused. It is complicated.

This is why we recommend that you consult with a qualified tax advisor on this new deduction. Every situation is different and we still do not have the final guidance on how this is going to work in very situation.

EML:

This concludes this segment of our video series. We hope you have found these to be informative and valuable. Please feel free to email me with general questions. NAR is not allowed to give specific tax advice but we may follow up with clarification in a subsequent video. Thanks for watching.

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Tax Reform

NAR continues to provide updates and guidance to members and is working to address additional concerns through future legislation and rulemaking.