How U.S. Real Estate Investors And Business Owners Can Reduce Their Taxes Thru the New Tax Reform
The Trump tax reform or the Tax Cuts Jobs Act (TCJA) created a new 20% business income deduction thru the 199A deduction section of the internal revenue code or IRC. The 20% business income deduction applies to pass-thru companies such as Partnerships, LLCs and S Corps.
The proposed regulations specify who will qualify for this 20% deduction. The deduction effectively takes the top tax rates from 37% to under 30%.
There are a few conditions and exclusions for taking this deduction:
- Bloomberg outlines that defined benefit plans, or simply what we have always called pensions, are allowed to be used by wealth manager, doctors, and law partners to significantly reduce their taxable income. They do this by reducing their income below the income limits that were created by Congress for the new tax breaks for pass-through businesses.
- There is renewed interest in pension plans. This is a change since the traditional pension plans have been being replaced by the less-costly 401(k) accounts by most employers.
- The contribution limits for defined benefit plans are based on the age of the taxpayer. In your 30s and early 40s you can deposit less than $100,000, but the contribution limits for older workers quickly increase. If you are in your late 50s, you can contribute over $200,000 and in your late 60s you can contribute more than $300,000.
- Business income from health, law, accounting, actuarial services, artists, consulting, athletic, financial services or brokerage services, 20% business income deduction is limited to the income of the business owners, which should not be over $315K oh their tax return for MFJ or $157.5K for singles.
- You can shield more of your income in a defined-benefit pensions than in a 401(k) defined contribution accounts or IRAs. Annual contributions max out at $18,500 for 401(k)s and at $5,500 for IRAs if you are under 50 years old.
- Businesses also must be sure they are cutting the owners’ tax bills sufficiently to pay for the increased costs associated with a defined pension. It costs thousands of dollars for the set up and administration of a defined-benefit plan.
- Business income from real estate and any other activity, 20% business income deduction is limited to the lesser of the 20% business income deduction and the greater of the 50% of the W2 wages of the business owner or the sum of the 25% of the W2 wages plus 2.5% of the unadjusted basis immediately after acquisition of all qualified property.
Real Estate business owners need to pay attention to their unadjusted basis in property to maximize their 20% business income deduction. Some may need to buy the property they rent or shift the debt to different properties if they own multiple buildings or re-leverage debt to maximize their unadjusted basis. Remember that debt reduces your basis.
If you have W2 income from other businesses apart from real estate, now is the time to determine if you need to decrease your W2 salary to avoid the limitation of the 20% business income deduction or the opposite if you have no W2 salary. Lack of W2 wages can limit you from taking the 20% business income deduction, but keep in mind that if this is not done under the internal revenue code limits, you may be in for an audit next year. The IRS has audited S Corps whose owners have not paid themselves a salary but take only their business income as pass-thru profits.
The points to consider on your tax plan are
- Individual’s income,
- Business structure,
- W-2 employees,
- Property ownership
If you are a real estate owner and your AGI is over the limits for the 20% business income deduction, you may use tax shelters such as IRAs or 401K, or a defined benefit plan to reduce your income and be able to take the maximum of the 20% business income deduction.
For example, if your business income at the end of the year is $170K and you are single, you are not able to take the 20% business income deduction (because the $157.5K limitation), but if you set up a 401K or SEP IRA, you can defer up to $55K (for 2018 if you are under 50), your business income is under the threshold and therefor you qualify for the 20% business income deduction and in addition save for retirement. If your income is over $170K, let say $250K, a Defined Benefit Plan will allow you to shelter up to $100K and reduce your tax liability as well as save for retirement.
In view of the tax changes, we are reviewing our clients’ financials to recommend the most suitable tax strategy for this fiscal year. Reach to us if you want to be reduce your taxes and plan for the future.
Contact us, we will glad to give you all information on how to plan for taxes for real estate investors.
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