House and Senate Tax Bills & Real Estate Investors

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Now that the House and the Senate have each passed their versions of the tax cut and simplification legislation, it’s time for them to reconcile the two bills. While there is a lot of detail and complexity in both, as far as real estate investors go, there are two different approaches, but both reduce income taxes on pass-through business income.

The vast majority of small real estate investors are what the IRS calls “pass-through” entities. Sole proprietorships, partnerships, LLCs and S corporations are pass-through entities for federal income tax purposes. This means that the business itself isn’t taxed on income, instead passing the income through to the personal tax returns of the owners. So, they are taxed at whatever rates their personal returns and tax brackets determine.

Both the Senate and House bills provide some income tax relief to pass-through entities, but they take different approaches. How they reconcile the two is important to real estate investors. There are no changes to the normal deductions for business expenses, including mortgage interest, property taxes, repairs, management, insurance, etc. However, once you’ve come up with your profit after expenses, the differences become important.

The House Tax Bill’s Provisions

The House bill takes a single and simple approach, taxing pass-through income at a maximum rate of 25%, down from the current 39.6%. With many real estate investors falling into tax brackets higher than 25%, this would be a nice tax break for these small business owners.

The Senate Tax Bill’s Provisions

The Senate maintains the current structure, taxing the income at the personal rates after passing it through to owners/partners. However, it does cap the rate at 38.5%. For many small real estate investors, this would make little or no difference in their final tax bill. However, the Senate bill would allow “most” pass-throughs to deduct 23% of their business income from taxation. “Most” is still not fully fleshed out, but there is no evidence that real estate investors would be excluded.

There has been no mention of any changes to the coveted 1031 Tax Deferred Exchange, hopefully keeping it alive and well for investors to grow their portfolios over time while deferring capital gains taxes along the way.

Either version, if outright approved in the reconciliation, would result in tax savings for real estate investors. However, there is a lot of back-and-forth going on and deals being made in this process, and then the final reconciled version will have to pass.

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