Promises and Pitfalls for
Real Estate Investors: The New Tax Law

A Conversation with Jason Ackerman, CPA

There has been a tremendous buzz about the sweeping overhaul of the tax code enacted late last year, but most taxpayers are only just coming to grips with what the changes might mean for them. The Tax Cuts and Jobs Act of 2017, signed into law by President Trump on December 22, 2017 provides a number of opportunities for tax savings for those who are savvy enough to plan ahead. It also includes several pitfalls that could increase tax bills, sometimes substantially. Jason Ackerman, CPA of Wagner, Ferber, Fine & Ackerman PLLC, a trusted strategic partner to Holm & O’Hara LLP, recently sat down with us to speak about what the new tax law holds in store for real estate investors in particular.

What is the biggest opportunity for real estate investors in the new tax law?

Without a doubt, it is the 20% deduction of qualified business income from pass-through entities, which most people have heard about. As they were lowering the corporate rate to 21%, lawmakers noted that the vast majority of small and closely-held businesses would still be taxed at the top individual rate of 39%. The 20% deduction is an attempt to bring taxation for pass-through entities (partnerships, S-Corps, sole proprietorships, LLCs) into alignment with taxation for larger businesses. Qualifying individuals can take this deduction from their personal income taxes.

Does every owner of a pass-through entity qualify for this?

No. There are a few tests. The first one is the personal income threshold, which is $175,500 for individuals and $315,000 for married couples. If you are below that threshold, you get the deduction. If not, there are some other tests you must pass before you get the deduction.

Owners of service businesses do not get the deduction once they pass the income threshold. This includes professional concerns like law and accounting firms, but also a broad range of other firms whose viability depends on their owners’ personal expertise.

Those who own non-service businesses – presumably including real estate concerns – then need to pay wages (non-wage distributions to owners do not count) and/or have qualified business assets – tangible items like buildings, furniture, computers. There is a specific calculation that lets you take either 50% of the wages your company paid or a combination of 25% of wages plus 2.5% of qualified assets. Once you have figured out which of these calculations works to your advantage, then you have to consider the formula for the maximum deduction, which caps out at 20% of qualified business income, subject to some other limitations.

Wagner, Ferber, Fine & Ackerman PLLC prepared a flow chart that illustrates this process a bit better. Certainly nobody is going to want to try to figure this out on their own; clients are going to need an advisor (or team of advisors) to help them make the right choices and plan ahead.

Are there industry-specific hurdles that confront real estate investors attempting to claim a personal deduction against qualified business income?

Definitely. For example, you cannot aggregate across entities. Real estate investors typically vest each property in an individual entity and not every entity pays wages – or has qualified assets. A management company might have only wages and no assets – and some property-owning entities may hold fully depreciated properties, which may not qualify. So a real estate investor’s ability to take the deduction could be limited based on which entities have qualified business income and how much they pay in wages, or by the basis of qualified assets, which may present a significant opportunity cost.

Should real estate investors consider changing their entity structures?

There is no single correct answer. It depends on the specifics. For example, if the real estate investor’s various enterprises pay a lot of wages, it may make sense to reconfigure the business so that most – if not all – wages are paid from a single entity. Certainly, it never makes sense to increase risk by consolidating property ownership. If there are multiple owners, you wouldn’t want to give up the LLC’s flexibility in sharing out income just for the sake of a tax deduction. On the other hand, single owners may want to take another look at the S-Corp structure for non-owning entities so they can leverage their flexibility to pay out wages. At this point, it makes very little sense to have property owned by an S-Corp, which is inflexible in many ways – and can really cause difficulties if you want to execute a §1031 exchange.

Does the new tax law offer any other opportunities for real estate investors to save on taxes?

The other major thing that real estate investors, particularly those with multifamily and residential properties, should be aware of is the expansion of bonus depreciation. The new law increases it from 50% to 100% and now allows deductions for used property. So real estate investors who need to replace furniture or various kinds of equipment may want to take a look at this. Commercial real estate has different rules for depreciation, but those opportunities have also broadened under the new law. There are two caveats, though. First, it doesn’t seem to apply to §179 depreciation for assets related to residential properties, where the entire cost of a purchase is written off when the equipment is put into service. We may see some clarification from the IRS on this point. Second, New York State is among those that do not recognize bonus depreciation, so it may have to be added back on state returns.

Is there anything that is still unclear, especially for real estate investors?

We are waiting on the IRS to advise on a whole range of issues. We have heard two things that are most likely to impact real estate investors. One is whether there will finally be a deemed reasonable salary for owners of closely-held businesses. The other, which is quite a bit more complicated, is whether real estate investors whose businesses own primarily triple net leased properties (NNN) are really eligible for the pass-through entity deduction.

What is the bottom line?

The new tax law introduces both a lot of opportunities and a number of complications. This makes tax planning more essential than ever. People who scramble for last minute tax savings in November or December are likely to lose out. With all the moving parts, you really can’t do this kind of thing after the fact, so you should get your advisory team together now.

Top of Page