While Tax Day 2019 may be a ways off, investors who currently own property or plan on buying one should learn about the new changes right now. While this year’s real estate taxes were left unscathed, the upcoming tax season will be a different story.
Why the Reform Matters to a Property Owner
Before we get into the details of the tax reform 2018 and how it affects your filing in 2019, it’s important to understand just why this matters. Ultimately, one of the major property expenses you’ll deal with happens to be real estate taxes.
Your investment property and primary residence are subject to property taxes based on their assessed value. Depending on where your property is located, how it’s assessed may somewhat differ. However, it’s the job of local officials to determine this value and the amount of real estate taxes due. Just keep in mind that the “fair market value” you might have found from your last comparative market analysis on your rental property might not exactly match up to the assessed value.
Real estate investors have to pay attention to property taxes because they affect the bottom line- the return on investment (ROI) – as any rental expense does.
That’s Why Tax Deductions Matter Even More to a Real Estate Investor
One of the many benefits of real estate investing that we’re always listing off is the fact that there are applicable tax deductions. If you’re not versed in what kind of real estate taxes can be deducted, you can end up with less of an ROI. That’s why the SALT reform is a hot topic in the world of property investing at the moment, causing some confusion.
The Reduction of the SALT Deduction
The amount that a property owner can claim for the SALT deduction was reduced significantly if that property is allocated for personal use. However, rental properties are still qualified for SALT deduction without limitation.
With that in mind, let’s look at what SALT deductions are exactly.
SALT stands for state and local taxes. This includes state and local:
- Property taxes
- Income taxes
- Sales taxes
(Filers have to choose between deducting sales or income taxes, depending on which is more for them.) So when you come to file your taxes in 2019, you’ll have two choices for tax deductions:
Standardized Deductions: This is a flat sum that depends on your filing status/disability status.
Itemized Deductions: This consists of listing applicable tax deductions, each with an individual sum.
Going with a standard deduction means you have no individual deductible expenses that would exceed this set amount. However, many people, especially real estate investors, typically find that they have higher deductible expenses. So, they opt for itemized deductions.
Here are some of the deductible expenses that can be itemized that are closely related to real estate taxes and owning a rental property or primary residence:
- Deductible taxes, including sales taxes and real estate taxes
- Mortgage loan points
- Mortgage loan interest
- Interest on Investments
- Business expenses, including some for travel
- Casualty, disaster and theft losses
SALT deductions are part of the itemized tax deductions, as shown above. Most of these items that are deductible expenses have a limit. However, before the Tax Reform 2018, the SALT deduction did not have a limit for the residential real estate of homeowners.
The initial plan for this real estate tax reform was to completely eliminate the SALT deduction. The final result was actually to cap them at $10,000 for homeowners.
Let’s look at the effect the SALT deduction limitation will have. For example, 34.14% of New York taxpayers claimed a SALT deduction on their tax returns in 2014. The average SALT deduction for this state was about $21,038. That’s more than double what the allowable tax deduction is now, including key real estate taxes.
Even if New York taxpayers opt for the standard deduction, the new higher set amounts may fall short depending on their filing status:
- Individual filers: $12,000
- Head of household filers: $18,000
- Married filers that file jointly: $24,000
A few other high tax states that will feel this effect when filing their tax returns and reviewing what they owe in real estate taxes are:
- New Jersey
- Rhode Island
These states specifically had a high average for SALT deductions ranging from about $12,000-$19,000- all above the new deduction limit.
So if you live in one of these states and own real estate property as a primary residence, come Tax Day 2019, you may not be able to save as much in real estate taxes as you had hoped. The best course of action? Plan for this hit now and make sure to adjust your budget ahead to accommodate this real estate tax reform.
Other Key Effects on Real Estate Investors from the Tax Reform
Now that we’ve cleared up how the tax reform affects real estate investors who own rental property in terms of the SALT deduction, let’s look at a few more changes.
Unfortunately for many real estate investors and investors in general, the investment fee deduction will be suspended until the year 2025. This means you can’t claim any deductible expenses on advisors, mortgage brokers, or the like on your tax return in 2019.
There is a new cap on mortgage interest deductions (interest paid on $750,000 principle value, down from $1 million). Just like the SALT deduction cap, this doesn’t apply to rental properties or even homeowners who already have an existing loan (taken out before December 15, 2017).
Another positive for real estate investors that came with the new tax law has to do with income from a pass-through business. This can include different forms of real estate syndication or even a real estate limited liability company, depending on their structures. Essentially, filers can now deduct up to 20% from their pass-through income.
The bottom line? The Tax Reform 2018 wasn’t too much of a bad thing for real estate investors. In fact, these conditions make it the best time to be a real estate investor. However, if you’re a real estate investor and a homeowner, you need to prep for the changes coming. While this post covers key changes, be sure to consult with a specialized tax accountant to help you when filing in 2019.