On December 20, 2017, Congress passed the Tax Reform Act (formerly known as the Tax Cuts and Jobs Act or the “Act”). With new reform comes new changes to the way we do business in real estate and how we are taxed on mortgages. In this article, I would like to list these changes in the most simple way possible so that you do not need to be a certified accountant to understand them.
The new bill reduces the limit on deductible mortgage debt to $750,000 for new mortgages taken out after December 14, 2017, on primary and second homes. Current jumbo loans up to $1 million are grandfathered in and are not subject to the new $750,000 cap.
Homeowners can still refinance their home loans up to $1 million on December 14, 2017 and still be able to deduct the interest, as long as the new mortgage loan does not exceed the amount of the existing loan being refinanced.
HELOC (Home equity line of credits)
Unfortunately, home equity line of credits (HELOC) for primary homes are no longer tax deductible in 2018. Homeowners will no longer be able to deduct interest paid on home equity debt through December 20, 2025. However, if the HELOC proceeds are used to purchase or improve an investment property, the related interest paid on the HELOC is tax deductible.
You will also be able to write off interest on home equity loans (or second mortgages) if a large part of the proceeds is used to improve the property.
Mortgage interest is tax deductible on second homes up to the $1 million – $750,000 limits. For strictly investment properties, mortgage interest continues to be tax deductible without the $750k limitation.
Cash taken out on investment properties continue to be tax deductible provided proceeds are used for investment properties and not personal expenses
Mortgage proceeds from a refinance cash out or a HELOC used from your primary residence to purchase investment properties may be tax deductible against rental income and escape the new limitation.
Deduction for State and Local Taxes
Homeowners will now be able to deduct up to $10,000 for the total of state and local property taxes and income or sales taxes which applies to both single and married filers. The bill also precludes the deduction of 2018 state and local income taxes prepaid in 2017.
The IRS has just issued an Advisory: Prepaid Real Property Taxes May Be Deductible in 2017 if Assessed and Paid in 2017. The Advisory states:
“The IRS has received a number of questions from the tax community concerning the deductibility of prepaid real property taxes. In general, whether a taxpayer is allowed a deduction for the prepayment of state or local real property taxes in 2017 depends on whether the taxpayer makes the payment in 2017 and the real property taxes are assessed prior to 2018. A prepayment of anticipated real property taxes that have not been assessed prior to 2018 are not deductible in 2017. State or local law determines whether and when a property tax is assessed, which is generally when the taxpayer becomes liable for the property tax imposed.”
Homeowners will continue to be able to exclude up to $500,000 profit from capital gains for a married couple and $250,000 for single people from getting taxed when they sell their home. It still remains that the homeowners would have to live in the property for two of the previous five years.
People who have properly structured real property exchanges will continue to enjoy tax benefits under IRS Section 1031. In fact, the amount of cash that is tax-free has doubled to $11 million for single people and $22 million for married people.
The Act modifies the IRS Section 1031 exchange provisions by limiting their application to real property that is not held primarily for sale and the portion of any 1031 exchange that includes personal property will no longer qualify for tax deductions.
Here is some more research from other publications and quotes to finish the article.
Ralph McLaughlin, chief economist at Trulia had said to USA Today;
“Those in the luxe category will be hit the hardest,” says It will also impact expensive coastal markets like California, Washington state, New York, Massachusetts and cities in Florida like Miami Beach. It will be a double whammy for people in those markets because homeowners there won’t be able to reduce their tax bill as much due to smaller allowed deductions for interest paid on big mortgages and high property taxes.”
According to a Washington Post analysis, tax reform would allow developers to deduct interest expenses for a variety of real estate activities, including construction, management, and property development.
Another provision would maintain the “like-kind exchange,” an exemption that lets a business avoid taxes if it reinvests profits in another business, except in the case of commercial real estate development. A New York Times analysis suggested this switch would allow owners of commercial real estate to “keep flipping the properties until they die without ever paying any capital gains tax.”
NAR President Elizabeth Mendenhall on Wednesday praised members for their rapid response, but warned that more work would need to be done in the new year as the impact of the tax revisions came into focus.
“The results are mixed,” said Mendenhall in a prepared statement. “We saved the exclusion for capital gains on the sale of a home and preserved the like-kind exchange for real property. Many agents and brokers who earn income as independent contractors or from pass-through businesses will also see a significant deduction on that business income. Despite these successes, we still have some hard work ahead of us. Significant legislative initiatives often require fixes to address unintended consequences, and this bill is no exception.”
Granger MacDonald, chairman of the National Association of Home Builders (NAHB) and a home builder and developer from Kerrville, Texas, issued the following statement after President Trump signed the Tax Cuts and Jobs Act into law:
“NAHB commends President Trump and members of Congress for their hard work and dedication in crafting this once-in-a-generation overhaul of the nation’s tax code. Providing tax relief for hard-working families and creating a more favorable tax climate for small business will make the economy more vibrant and competitive. In turn, this will boost the housing sector, which represents roughly one-sixth of the U.S. economy. Housing not only equals jobs, but jobs mean more demand for housing.”