Many multifamily real estate investors and owners are interested in finding out how Trump’s new tax plan will impact their investments. The proposed tax framework that the Trump administration published last week outlined a few key pieces of information that investors should take note of.
The first one is that pass-through entities such as limited liability companies (LLC’s) will now be taxed at 25%. What does this mean for real estate investors? Under the current tax code, income from pass-through entities is reported on the individual's tax return and thereby is currently taxed at the regular income tax rate. With this new change, income earned from your LLC or other pass-through entities will be limited to a 25% tax rate, completely avoiding higher tax brackets. This is great news if your personal income is more than 92K per year. However, if you earned less than 38K per year, you will still pay the 25% on your LLC's income. The taxes in this case would be higher than if it had passed through the LLC without taxation.
A second interesting change is that capital costs are immediately deductible. This is a welcome change for most investors who under the current tax law have to worry about complex depreciation schedules, meaning extra management time and accounting costs. Instead, when a new property is purchased, the entire value of the building (not including the land) can be written off against any taxable income made in that tax year. If this results in a net operating loss (NOL), then this loss can be carried forward indefinitely. The NOL can also be increased by an interest factor each year to compensate for inflation.
This creates an interesting scenario where you can offset all capital gains from a property you sell by purchasing a new property and using the NOL from the new property to offset the gain from the property you sold. It also means you can reduce the taxable income made by your property until the NOL is completely paid off. It is likely that the other 1031 exchange law will be repealed as part of this tax reform package. The main catch here is if you sell one property in the current tax year and purchase the second property in the next tax year will have to pay the capital gain as you won’t have the NOL in the current tax year to offset it. If you need to do this, it would require some planning ahead.
The final change that investors need to know about is that interest payments on debt service might no longer be tax deductible. This will mean that investors might no longer be able to write off mortgage interest payments. The result of this is that some investors may find that a portion of their marginally profitable real estate investments are no longer profitable. In this scenario, it might be better to sell this asset and purchase a newer asset that is going to yield a higher return.
It will be interesting to see if these proposed changes will become reality. Stay tuned for more updates!
This blog post is our interpretation of the changes to the tax law that the Trump administration has proposed in their tax frame work press release. It is not intended as tax, legal or investment advice, so please consult with your tax, legal or investment professional before making any changes to your portfolio based on the information presented in this blog post.