The new tax laws have impacted everyone, from renters to homeowners to real estate investors. Whether you’ve gained money every paycheck, owe more at the end of the year, or things haven’t changed significantly, you may wonder exactly what the new tax laws mean for you.
Wading through the IRS rules can take a long time and still leave you confused, but figuring out what applies to you and what doesn’t is important to know how to fill out your tax returns.
If you own real estate as an investment, whether you’ve rented it out or you are developing it for some future purpose, understanding the laws is especially important for you.
In the past, there were many benefits for those who owned real estate investments when it came to filing their taxes. With the new tax laws, some of the benefits have changed and shrunk a bit, but there are still a variety of positive reasons to own property. Read on to find out what the new tax laws mean for your investment:
MORTGAGE INTEREST DEDUCTIONS
Prior to 2018, property owners could deduct the interest paid on mortgages – including mortgages on second homes and investment properties – as long as the total value of the property was under $1 million.
This allowed many real estate investors to deduct the interest on a large portfolio of properties and made widespread rental property investment attractive for anyone who had the ability to carry multiple mortgages.
However, the new tax laws mean that the threshold for mortgage income deductions has been reduced to $750,000.
As a real estate investor, that means your ability to deduct mortgage interest has been decreased by one-quarter. For many, this is a significant difference and could greatly influence your future investment decisions.
HOME EQUITY FUNDS
Even as a real estate investor, you can take out a home equity line of credit (HELOC) to buy, build, or improve your properties. These funds also can be used for other purposes, such as paying off other debts.
Prior to 2018, you could deduct the interest paid on these HELOCs even if you used the funds for purposes unrelated to your properties.
The new tax laws mean you can only deduct interest paid on any HELOCs if they’re used to buy more property, build property, or significantly improve the property you have. The deduction limits remain the same as they did in the past.
FLOW-THROUGH INCOME
If you’re a real estate investor who buys properties, fixes them up, and then flips them for sale, you get a 20% tax break on your profits as flow-through business income.
Say, for example, you purchase a property, fix it up, and sell it for $100,000 in profit. The first $20,000 of that profit is at a zero tax, meaning you’re taxed on $80,000 of the profit instead of the full $100,000.
This income deduction is available for income earned through an S-corp, an LLC, or a sole proprietorship, so you don’t even have to have a legal business entity to qualify.
CHANGES FOR LANDLORDS
Landlords also are eligible for the 20% zero-tax deduction, provided they meet certain requirements. Depending on how much your rental income changes your overall income, it may be worthwhile to meet these conditions to see the benefits of the tax break.
The four conditions landlords must meet are:
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You must keep separate books and records for your rental activities
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You must log more than 250 hours of rental activities annually
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You must have contemporaneous records to keep track of these hours and activities, and
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You must attach a signed statement to your tax return to indicate the requirements have been met.
Those 250 hours can be an accumulation of hours logged at all of your rental properties. For example, if you own five rental properties and spent 50 hours working on each property, your 250 hours would be fulfilled.
Activities that count to meet these requirements include:
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Maintenance
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Repairs
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Rent collection
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Payment of expenses
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Activities in order to rent the property
These activities also do not need to be performed by you alone; your employees, contractors, and agents can conduct any of these activities and they can count toward your 250-hour total.
BONUS DEPRECIATION
This change is a big plus to anyone looking to improve their rental properties in the near future.
If you add something to your rental property that will depreciate in less than 20 years, you can write it off entirely within the first year. Prior to 2018, you could only deduct 50 percent of the item’s value.
That means you can go ahead and add that new carpet to your rental properties; you can deduct the full amount in the first year. The deduction also qualifies for any of those small improvement projects – repainting, filling holes, and replacing light bulbs – that need to be done after a tenant moves out to prepare the property for the next person.