How Realtors Can Take Advantage of The Trump Tax Reform
Most high earners are very excited about the new tax laws that went into effect, but there is still a question about whether or not real estate brokers and their existing firms will be able to take advantage of deductions that are given to pass-through businesses. Pass-through deductions have been great for independent contractors like freelancers and Lyft or Uber drivers but most still haven’t been sure about the grey area of real estate and how it the tax return can be affected. According to Therealdeal.com, brokers will qualify automatically for the twenty percent deduction assuming they are earning less than $315k if filing jointly or $157,500 as a single. There are some other restrictions that apply, but that usually only is in reference to those who live in expensive cities like Los Angeles, or New York and make significantly more than that. The income limits are pretty low which has been a headache for some brokers. Some of the other things to consider for brokers who are above the income limits but are still trying to secure the deduction are:
- There is an exemption given to “specified service” businesses. These are businesses like accounting, law, health, performing arts, consulting, financial services, brokerage services, actuarial sciences and athletics, or “any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners”. Could real estate brokers get this deduction? Whether or not the brokerage services definition includes more than just financial brokers and includes brokers of any kind that are brokering things, remains unclear for most. Obviously brokers have to market themselves based on experience and knowledge and often times rely on their personal skill and reputation. Many brokers are changing the way they market their business to try and make a more clear-cut case for qualifying for the deduction, and not being stuck in the exemption category.
- This deduction is available from 2018-2025 and then will expire. So businesses should figure out how to not become reliant on the extra cash the deduction may offer for a short period of time.
- Initially everyone was waiting for the IRS to issue more guidance on the issue (and they have, we will cover it below). Without more guidance, and as it stood real estate brokers who were determined to be a “specified service” kind of business, would not qualify for the deduction if joint filers made more than $415k a year and single filers $207,500. It was hard to know what the IRS would decide. So tax professionals took the approach of advising against speculating and then trying to preemptively change a business model or practices, in anticipation of what a tax payer thought the IRS would do. After all, being wrong and guessing incorrectly could be a very costly mistake.
- Another challenge was based on how a taxpayer files their taxes. Most real estate brokers file 1099’s as independent contractors instead of W2’s. That’s a problem when the formula for trying to calculate whether or not there will be a limitation on the deductions given involved the use of W2 income and will not calculate using any 1099 income. Bottom line, if you were planning to file with a 1099 then you most likely would not get a deduction.
- There is also going to be an impact on home sales due to a new tax law and will make this next spring one of the slowest selling seasons that we’ve ever seen (at least according to the Wall Street Journal). The tax law in question is the new cap that was put in place on deductions for state and local taxes as well as mortgage-interest deductions. The flip side though, is that these changes are great for businesses and business owners who are more likely able to afford high net worth type properties. So some seem to think if you are a broker doing deals above $3million then you’ll probably come out ok and not see the effects of this as much as those brokers who are dealing more with middle-class America who relied on the deductions to help their tax returns.
Many professionals in the real estate market have been trying to restructure S-Corporations and other entities to figure out how to maximize their deductions. The good news is, that the IRS says there are all sorts of ways that real estate brokers can qualify for and maximize their deductions. Fret not, the IRS knew they were confusing people and they issued proposed rules to try and clear up the confusion about whether or not real estate brokers could qualify for the pass through deduction of 20%.
Again, according to an updated story over at therealdeal.com the IRS now specifically lays out that real estate brokers, insurance brokers and their respective agents are not excluded. That may have helped clear up the confusion, but real estate brokers should still consult an experienced tax advisor because the rules and regulations around income limits and deductions are still pretty complicated. Some of the complications come from these limitations:
- The formula for trying to determine if a broker can qualify for the deduction if they are above income limits is still based on W2 income and not 1099 income.
- Wage restrictions for the deduction is still $157,500 a year for an individual or $315,000 for joint filers.
Another question surrounding all of these new changes is that no one is clear on how they apply to landlords who are in the business of collecting rent with triple net leases. How will this new law apply to them? Can they qualify for the 20% deduction? We suppose it all depends on whether or not they need the definition of an active “trade or business”. In either case though, this new law seems to be working out well for real estate brokers but you’ll want to meet with your qualified tax professional to make sure you’ve got yourself covered in any case.
If you have more questions about Real Estate Broker deductions, send them to us.
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