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Trump’s Tax Returns Lessons Learned: Minimizing Tax Burden in the Real Estate Business

Your will learn: advanced tax avoidance strategies.

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last update Thursday, October 15, 2020
  

 



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President Donald Trump's tax returns details revealed by the New York Times last month scandalized most of American society and had a huge impact on an international level. In 2016, the year he ran for the presidency, and during his first year in the White House, he only paid $750 in federal income.

While Trump’s tax avoidance was massive and clearly controversial, it cannot be proven illegal. It is widely known that many US millionaires use any kind of loopholes to pay as little tax as possible. But how do they do that? 

What can the real estate business leverage from Trump’s experience? Paperfree points out four key benefits that real estate investors can take from the Tax Cuts and Jobs Act (TCJA), based on a webinar hosted by the tax expert Alicia Miller.

A Major Tax Reform

Signed into Law on December 22, 2017, the Tax Cuts and Jobs Act (TCJA) was the most significant tax legislation approved by the US Congress since 1986. The reform made significant changes that affect both companies and individuals.
The TCJA includes some points that, if properly used, can be leveraged to reduce the tax burden in the real estate business. The key benefits are included within the following segments:

  • Depreciation
  • Qualified Business Income Deduction
  • Interest Expense Limitation
  • Opportunity Zones

Depreciation

Depreciation is the deduction of a property cost but instead of doing it all in one tax year, it is written off by parts. It is the distribution of such deduction across the useful life of the property. 

Depreciation is a non-cash deduction. You may be cash flow positive but for taxable income, you may not have any taxable income because depreciation is driving your tax law down. This means that even catching distributions, you are not paying any tax on that cash. In other words, tax-deferred cash, which is a huge benefit.

The TCJA has brought some changes that benefit the real estate investors:

  • 100% bonus depreciation
  • Expensing Depreciable Business Assets (Section 179)
  • Cost segregation study
  • Tangible Property Regulations

100% bonus depreciation

Bonus Depreciation or additional first-year depreciation deduction- is the possibility of obtaining a significant and immediate deduction of the cost of a qualified asset, instead of writing it off over the course of its useful life.

It was introduced in 2002 to stimulate the economy by enabling businesses to recover the cost of capital acquisitions more quickly. The tax reform has made some changes:

  • Bonus depreciation was increased from 50 to 100% for qualified properties.
  • Anything under 20 years is eligible for bonus depreciation.
  • It applies to properties acquired after September 27, 2017, and placed in service before January 1, 2023.
  • This is now available on the used property.
  • No taxable income limitations, meaning it can drive you below zero. 
  • Qualified improvement properties (interior improvements like remodeling that don’t enlarge the building) are no longer separately defined as a 15-year asset, meaning that you can now take bonus depreciation on.

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Section 179 Expensing

TCJA has modified the definition of section 179 property to allow the inclusion of certain improvements made to nonresidential real property. It gives real estate clients the opportunity to write off the Qualified Real Property in year one, a huge deal.

  • This includes most improvement to a building’s interior, roofs and HVAC systems, security, and fire protection.
  • Now amounts of $1 million and $2.5 million will be adjusted for inflation.
  • It has many taxable income limitations.

Cost segregation study

Cost segregation is a tax planning tool that allows owners of properties who have purchased, constructed, or remodeled any kind of property to increase cash flow. They can do this by accelerating depreciation deductions and thus federal and state income taxes get deferred.

The cost segregation study is an analysis of assets constructed, acquired, or renovated to properly allocate costs to the different classes. It breaks it down into the useful life of the property. The price of the building is dissected into different components that can be written off much quicker (5, 7, or 15 years) than the building structure (over 27.5 or 39 years). So you recover it faster. You see the benefit much quicker.

Implications of the TCJA reform:

  • Now that you can take bonus depreciation over a used property, the cost segregation study makes more sense. 
  • It has tangible property regulations (TPR) implications.

Tangible Property Regulations

The Tangible Property Regulations (TPR) dates from 2012 and includes certain expensing opportunities. It looks at repairs and maintenance vs. capital improvements. With the cost segregation study, you break that building down into different units of property. 

This is important because under the TPR you might be able to expense something that isn’t a substantial part of a unit of property. You take the deductions all in year one, no limitations, this is great.

The TPR gives some guidance in terms of what is a natural repair, which is an improvement when it is required to be capitalized. 

Qualified Business Income Deduction

Many proprietors, owners of sole proprietorships, partnerships, and S corporation may be eligible for this new deduction -referred to as Section 199A- also called Qualified Business Income Deduction. It allows a deduction of up to 20% of their qualified business income.

  • It includes domestic income from a trade or business. 
  • It does not include employee wages, capital gain, interest, and dividend income.
  • It is generally available to eligible taxpayers whose 2018 taxable incomes fall below $315,000 for joint returns and $157,500 for other taxpayers. 
  • High-income taxpayers are subject to limitations based on a lessor of 50% allocated wages or 2.5% unadjusted basis after the acquisition of property plus 25% allocated wages.
  • IRC 1245 gains may be potentially eligible for QBI deduction.
  • This section expires at the end of 2025.
  • Triple-net lease structures are normally not eligible for a 20% deduction.
  • Bonus depreciation allows deducing all in year one, but in that case, you are walking away from the 20% deduction.

This is huge on an investor level. In terms of real estate they are making it equitable so now if you are getting a partnership income -depending on the limits- you might get a 20% deduction on the partnership income. 

Interest Expense Limitation

The Interest Expense Limitation extracted from IRC Section 163 (j) is not necessarily a benefit. It’s an implication of cash alone but it involves a very unique benefit for real estate. It is a limitation on the amount of interest expense that a business is able to deduct.

The formula is 30% of the Adjusted Taxable Income (the number was modified by the CARES act) In a couple of years, if you have taxable income, you actually get to add that back taking the taxable income up.

  • Very unique exception for real estate.
  • It is an irrevocable election.
  • If a real estate entity is enabled to use this election, many projects can be highly leveraged.
  • Business with average gross receipts of $26M or less = exempt.
  • It enables them to deduct all their interests with no limitations.
  • If you make the election, you are giving up opportunities for bonus depreciation.
  • You can get some benefits from the cost segregation study.

Opportunity Zones

Qualified Opportunity Zones are an economic development tool created by the 2017 Tax Cuts and Jobs Act. They have been designed to spur economic development and job creation in distressed communities throughout the country. They provide tax benefits to investors who invest eligible capital into these communities.

  • Tax benefits for investments in certain regions.
  • Tax deferral on capital gains (if you can defer taxes).
  • Permanent exclusion on a share of capital gains.
  • Permanent exclusion on 100% of future appreciation. After 10 years you are still holding that asset, maybe you share the values now Need capital gain
  • Date to remember 31-Dec-2026.
  • Leveraged property is ok. Not separate non-qualified investment.
  • Existing property – Restructure complex.
  • Good investment opportunity?

For more information, watch the full video

 

Originally content was published on the page https://vcmgam.com/2020/04/22/webinar-4-key-real-estate-tax-benefits/ 


       
 

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