Given the new proposed United States tax plan from the Trump administration, investing in real estate has some potential implications for a new investor. Most consider the changes extremely beneficial to first-time real estate investors in particular.
To cover the basics first, the existing tax structure allows for real estate investors to write-off all the expenses of owning and running a rental as those properties are considered a business operation. In addition, any interest on the mortgages for these investments along with any repair or management costs can be deducted pre-tax on the total income of the property so that the property owner is only taxed on the actual cash flow they’re earning from the investment.
None of these existing standards would change in the proposed tax-plan, but there are some new additions to look out for that could incentivize real estate investing and lower home sale prices.
Let’s take a look at how this plan can impact the industry and externalities in the fine print.
New proposals in Trump’s Tax Plan
Deductions for pass-through companies
Many experienced real estate investors will put the title of their investment property under a sole proprietorship, LLC, or S-corp for a variety of reasons including reduced risk in litigation, privacy, and tax benefits. These organizations are considered pass-through companies and they avoid double taxation rules of paying both individual and corporate taxes. Instead, taxes are just applied at the individual level.
The new tax plan proposes an additional deduction for pass-through companies. The plan adds a new 20% deduction on your net income after amortization and depreciation if you’re set up as a pass-through company. Alternatively, you may receive a 2.5% deduction on your property’s unadjusted basis–not including the value of the land.
To fully understand the value of the deduction, you need to understand the full amount of qualified business income and then consider the following breakdown. The deduction is the the sum of:
The lesser of:
- Combined Qualified Business Income, or
- 20% of the excess of: the taxable income divided by the sum of any net capital gain
And the lesser of:
- 20% of the aggregate amount of the qualified cooperative dividends of the taxpayer, or
- taxable income reduced by the net capital gain
So what is combined qualified business income?
Combined qualified business income is the lesser of:
20% of the qualified business income with respect to the qualified trade or business; or the greater of:
50% of the W-2 wages with respect to the qualified trade or business, or
The sum of 25% of the W-2 wages with respect to the qualified trade or business, plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property
What does this all mean for someone looking to invest in real estate?
Well, it essentially means it’s now more profitable to own income-generating real estate assets such as single-family rentals, apartments, or condos. Instead of paying the regular income tax rate, you can create an LLc for $800-$1,500 and take advantage of the new 20% “freebie” deduction for pass-through companies.