by Kenneth Ziskin, The Apartment Owners’ Estate Planning Attorney SM
Tax reform finally became law late in December, 2017, even though passage required it to give up its common name, the Tax Cut and Jobs Act (“TCJA”).
For most of you, the TCJA will give with one hand, and take away with the other. For some, the act will be a lump of coal, and taxes will, unfortunately, go up. For others, the act will be a real Christmas present that brings real tax savings. You probably cannot just intuitively figure out whether you got a real present or a lump of coal until you model your situation, and possible planning opportunities.
Many of the law’s provisions were not finalized, or even discussed, in committee, and we will not understand the full impact for months, or maybe even years. But, while all tax professionals (including me) are trying to get a handle around the impacts of the TCJA, I want to try to give you an idea of some of the major impacts and a few planning implications.
LUMPS OF COAL
Limitation on SALT Deduction
California did not fare too well in this law, maybe reflecting the lack of GOP Senators and Representatives from the Golden State.
The big hit: A major limitation on SALT deductions (generally, to $10,000 per year for an individual or MFJ – married couple filing jointly). [These have nothing to do with flavoring your food.]
SALT deductions were the itemized deductions you could take for State and Local Taxes. In California, these SALTs can be pretty big, either due to high state income tax rates or high property tax assessments.
This could have been worse. Until the Conference Committee added some clarifying language to its report, we feared the SALT deduction limitation could apply to property taxes on both your home and your income property.
Limitation of Business Interest Deduction
While not a problem for most of you, the TCJA now limits deduction of business interest, with a few exceptions, to 30% of “adjusted taxable income” from affiliated groups that have more than $25 million of annual gross receipt.
End of Like-Kind Exchanges of Personal Property
This is one of several provisions that may make cost segregation less attractive.
Although the vast majority of tax dollars will be saved by the very wealthy, the GOP expects that the biggest benefit of the TCJA will be its stimulus to employment and the economy. If the Laffer Curve proves valid, this may produce a rising tide to raise everyone. Note, however, that most of the savings for people, as opposed to corporations, will sunset after 2025.
Rate Reductions for Almost Everyone
Almost every tax bracket gets a slightly lower rate (a few percentage points), and the level at which most rates rise is generally increased. The top rate fell (at the last minute) from 39.6% (before the 3.8% Net Investment Income Tax, which, sadly, did not get repealed) to 37%. For some, this, combined with an increased standard deduction, will mean savings greater than what they lose in SALT deductions.
Major Reduction in Corporate Rates
C-Corporations, those that pay taxes instead of passing income through to their owners, got the biggest present of all, with the top rate falling from 35% to 21%. And, this reduction is not scheduled to “sunset,” although a future Congress and President can always change the law.
As significant as this change may be, for most real estate businesses it will not make sense to convert to C-Corporation status.
Expanded § 179 Deduction
The TCJA expands the amount of business property a taxpayer can just write-off, instead of depreciate, to $1 million from $500,000, with more liberal rules on the phase-out of this deduction for larger earners. But, this may adversely impact on the pass-thru deduction discussed below.
Pass-Thru Business Deduction
All year, both the House and Senate made it clear that they wanted to give relief to small businesses (partnerships, LLCs, sole proprietorships) that were not organized as C-Corps. While the House wanted to reduce the top rate on income from these businesses to about 25%, the Conference Committed adopted the Senate approach which allowed a limited special deduction from income from these businesses.
Until the last minute, it looked like rental property owners would be left out in the cold from this special deduction. But then, the Conference Committee changed the bill, to allow real estate businesses to use this deduction under certain circumstances.
So, starting in 2018, until it sunsets after 2025, the TCJA allows for a special income tax deduction of up to 20% of Qualified Business Income (“QBI”) for pass-thru businesses.
However, despite the GOP desire to simplify tax rules, calculating whether, and how much, you will benefit from this deduction has become really complex. The analysis which follows will probably seem overly complex, but, in reality, it overly simplifies the limits which will apply to the QBI Deduction. Still, for those who can use it to the max, it will be a big deal, and probably seem to be worth the trouble to calculate (and maximize) your ability to use the QBI Deduction.
Generally, the QBI Deduction will equal up to 20% of Qualified Business Income measured on an entity-by-entity basis. QBI starts as the income effectively connected with the “qualified business activity” in the US, after depreciation and interest, which is included or allowed in determining taxable income from the activity for the taxable year. But, if the taxpayer/owner’s taxable income (from all sources) exceeds a threshold amount ($315,000 for an MFJ, and $157,500 for others), the deduction will at least be reduced. If such taxable income is over $415,000 for an MFJ (207,500 for others), the QBI in a real estate business will be limited to the greater of 50% of W-2 wages, or 25% of W-2 wages PLUS 2.5% of “unadjusted basis.”
Unadjusted basis is the cost basis of depreciable tangible property, so it does not include land, but only as long as the depreciation period has not expired. The depreciation period ends generally when depreciation would normally expire (27.5 years for residential rental property) or, if later, 10 years after acquisition of the property. NOTE: Most advisors believe that the step-up in basis on death, where applicable, will both restart depreciation at the stepped-up value, but also increase the “unadjusted basis” of property, giving the potential for greater QBI deductions.
While each situation needs to be individually analyzed and modeled, a few general principals apply to maximizing the QBI deduction:
- It works MUCH BETTER if your taxable income remains below $315,000 for a married couple, and $157,500 for others. Of course, that means the deduction produces less tax saving than for those in a higher bracket.
- Leverage can create problems for the QBI Deduction.
- Cost segregation, bonus depreciation and 179 deductions may reduce the QBI Deduction.
- Buildings acquired long ago, or whose basis is largely determined using the basis of low-basis property as a result of a like-kind exchange, will not support much of a QBI Deduction unless, and until, there is a step-up in basis.
- The QBI Deduction can probably be enhanced every other year through careful timing of income and expense.
Doubling of Death and Other Transfer Tax Exemptions
The GOP has long wanted to eliminate estate (death) taxes and other transfer taxes such as the gift tax and generation skipping transfer tax. Amendments to the tax code in 2001 and 2012 left very few people subject to these transfer taxes.
In the TCJA, the GOP faced fiscal and procedural limitations which again precluded repeal of these taxes, but it did double the amounts exempted therefrom, to $11.2 million per person in 2018. But, this doubling sunsets after 2025. So, it may make sense for those facing substantial estate tax exposure, now or after 2025, to take steps to use the exclusion, and maybe leverage it, before 2026. The doubling of exemptions, while in effect, offers many opportunities to reduce family income taxes if Mom and Dad do not need to spend all of the income generated by their property, although this involves careful planning and analysis. Given the expanded importance of the step-up in basis, careful planning is required to evaluate the benefit of getting these estate tax savings vs. getting a step-up in basis. I generally recommend strategies that will allow a client to preserve the step-up for highly appreciated property while reducing the amount subject to transfer taxes.
SUMMING IT ALL UP
It is going to take a while for property owners, and their advisors, to figure out the best way to benefit from the TCJA. In many cases, it will require modeling the owner’s existing position and possible strategies the owner could implement.
But that just emphasizes our motto: “IF YOU FAIL TO PLAN WELL, PLAN TO FAIL.”
To help property owners understand their planning options, we have scheduled our Estate Planning for Apartment Owners seminars in Southern California for:
MARCH 15 in BUENA PARK
MARCH 22 in VAN NUYS
MARCH 27 in TORRANCE
Each seminar will start at 10 AM and run until noon, with an extended Q&A (including issues and examples of QBI case studies) until about 1 PM if possible.
We are also planning to schedule seminars in San Jose and Oakland in May or June.
Call my office at 818-988-0949 to reserve a spot, or request a reservation by email to ZiskinLaw@gmail.com. These seminars usually fill up early, so please register as soon as possible.
TO LEARN MORE, REGISTER TO ATTEND KEN ZISKIN’S SEMINAR ON “ESTATE PLANNING FOR APARTMENT OWNERS”. Seminars are scheduled for Thursday, March 23, 2017 in Van Nuys and Tuesday, March 28 in Torrance.
WE EXPECT THESE SEMINARS TO BOOK UP QUICKLY. PLEASE CALL (818) 988-0949 TO RESERVE A SPOT AS SOON AS POSSIBLE. If we are booked, we will try to schedule an extra session if we get enough requests. You may also request a free personal consultation with Mr. Ziskin.
Kenneth Ziskin, an estate planning attorney and AOA member, works with his wife Hinda, to provide integrated estate planning for apartment owners to save income, property, gift and estate taxes, and protect apartment owners from long-term care exposure. He is a member of both WealthCounsel and ElderCounsel. He holds the coveted AV Preeminent peer reviewed rating for Ethical Standards and Legal Ability from Martindale-Hubbell, a perfect 10 out of 10 rating from legal website AVVO.Com, and is multiple winner of AVVO’s Client Choice Award. See Ken’s website at www.ZiskinLaw.com. It includes reviews by many of his clients.
This article is general in nature and not intended as advice for clients. Please get advice from counsel you retain for your own planning. Remember also that the TCJA was only written a few weeks ago; everyone’s understanding of its implications is likely to get better as we work with the law and discuss it with our colleagues.