New Regulations Clarify Tax Treatment for Real Estate Industry
- Personal Finance
Business owners in the real estate industry should be pleased with new tax regulations interpreting the Tax Cuts and Jobs Act.
The regulations, which were proposed on Aug. 8, clarify that real estate brokerages and real estate agents are among the businesses that qualify for the pass-through tax break. Initially, it was not clear that real estate brokerage and agent sales activities qualified for the pass-through tax deduction when the law passed in 2017. This is because the law specifically excludes most service-related businesses from the pass-through tax deduction, including financial services brokerages.
By way of review, the pass-through tax break provides up to a 20 percent reduction in income of qualifying pass-through entities. For example, a qualifying business in the highest marginal income tax rate of 37 percent, which begins at taxable income over $600,000, would enjoy a marginal income tax rate of 29.6 percent. It is important to note larger real estate businesses may not qualify for the full 20 percent tax rate reduction unless they have significant investment in depreciable real estate and/or pay significant wages.
The 20 percent pass-through deduction formula, as it applies to real estate businesses, rewards businesses with large income-producing assets that are otherwise depreciable under the tax code. In addition, the new law provides larger tax deductions under the pass-through tax break to businesses that have large payrolls. Channeling the greatest tax breaks to businesses that hire people (like manufacturing) or invest in income-producing real estate (like commercial and residential leasing) drove the design of these provisions by Republican policymakers in Washington.
In addition, the new tax law provides the tax cut to entities in the fields of engineering and architecture. The policy justification is that many of these businesses are involved in the real estate industry and also deserve the tax break.
The proposed regulations also provide clarity regarding common situations involving a business that generates both qualifying or “good” pass-through income and also non-qualifying or “bad” pass-through income. When the law passed, tax experts were concerned some bad business income might disqualify all good business income from the pass-through tax deduction. As it turns out, the regulations include a de minimis rule where a small amount of bad business income does not disqualify the majority of good income. Under the de minimis rule, a business with $25 million or less in gross revenue can qualify for the pass-through deduction for the good or qualified income if less than 10 percent of gross revenue is derived from bad or unqualified income. Larger businesses can qualify for the pass-through deduction if their bad or unqualified income is less than 5 percent.
For example, this rule would be helpful to a pass-through business that owns and rents apartments and also provides real estate consulting services. The rental business generates both good or qualifying pass-through income and bad or unqualified consulting income (consulting services generally do not qualify for the pass-through deduction). As long as the consulting income meets one of the de minimis rules noted above, the rental income qualifies for the pass-through deduction.
And last, the proposed regulations include a nice surprise for pass-through business owners with multiple related businesses. Generally, the regulations allow (but do not require) business owners to aggregate qualifying businesses where they own at least 50 percent of each entity and the businesses generally provide the same products, services or share business elements. Aggregation can help business owners maximize their overall pass-through tax deduction by combining income, wages and depreciable property, key elements in the pass-through tax deduction formula.
On September 27, 2018, at 3 P.M. ET, Boston Private will host a webinar with tax experts discussing the proposed regulations in greater detail, cover common examples involving real estate investing and offer planning tips to maximize your pass-through tax break.
Boston Private is pleased to announce a partnership with Doug Fisher, a Washington Policy expert, who will offer a series of insights into a number of reform proposals making their way through Congress in 2017. Doug is Director of Retirement Policy at the American Retirement Association. In this role, Doug works with the ARA membership to protect, advise and grow their businesses through ideation and advocacy in the benefits area. Before joining ARA, Doug led Fidelity's legislative policy and thought leadership development teams involving retirement, health and welfare benefit plans. Doug has advised many Fortune 1,000 companies on the impact of legislation and regulation on the design and delivery of benefits. Before joining Fidelity, Doug served as tax counsel to the U.S. Senate Finance Committee and was involved in writing the pension, health and insurance provisions of the Small Business Job Protection Act of 1996; the Balanced Budget Act of 1997, including the Roth IRA, Simple retirement plan, medical savings account (predecessor to the health savings account); and the Health Insurance Portability and Accountability Act of 1996 (HIPAA).
- Personal Finance