130: What Is Changing with the Real Estate Tax Code?

Earlier this week, I wrote an article about the new tax code and how it could affect the real estate market. I decided I would do a podcast on it as well since I know many of you prefer to listen than to read. On this episode of the InvestFourMore Real Estate Podcast, I go over the possible tax changes that will be coming soon. The tax codes are not official yet, but we have a really good idea what will happen based on the two bills that have been passed by the House and the Senate. The tax law will not help out homeowners, but it will help real estate investors.

[0:00:13.6] MF: Welcome to the InvestFourMore Real Estate Podcast. My name is Mark Ferguson and I am your host. I’m a house flipper. I flip 10 to 15 houses a year. I own 13 rental properties with a goal to buy 100 by 2023. I’m also a real estate agent. I’ve been licensed since ’01. I run a team of nine and we sell close to 200 houses a year.


So, on this show, we’d like to interview house flippers, landlords, and the best real estate agents in the business. So, stay tuned for some great shows. If you want more information on my rentals, on the numbers, how I buy properties? Check out investfourmore.com.


Hey everyone, it’s Mark Ferguson with InvestFourMore. Welcome to another episode of the InvestFourMore Real Estate Podcast. Today, we’re going to talk about taxes so, have new bills coming out of the house of Senate. Lots of big changes in the real estate world, I want to talk about all that. Nothing is final yet, but we have a good idea of what’s going to happen and how we should all be preparing for those changes.


Before we get in to that of course checkout investfourmore.com. I wrote an article on this as well that goes in to all the details I talked about on this podcast, I would link to that in the show notes you can get the written version if you want that and yeah, so let’s get right in to it.


First off, this is not a minor change to the real estate tax code. These are some huge changes that will affect homeowners and investors greatly. Home owners are not going to be affected in a good way. Investors most likely will be affected in a good way. Like I said, one bill was passed by the house, November 2nd, another bill was passed by the Senate just a couple of days ago. What has to happen is both the house and the Senate have to pass the same bill so they’ll get together now, come over the same bill, vote on it, if they both approve it then the president signs off on it and it will become law.


So, there are some differences between the two bills for sure but there are very similar things in both bills in regards to real estate and taxes that we can assume will stay the same for the final bill that is passed. So, that gives us an idea of what to expect as agents, as investors, as homeowners, and how things will change. So, first I want to go over with some of the changes are for homeowners. Since many of us are homeowners we all have a house, there are some big things that are going to happen for all of us. And the first thing a lot we will talk about, the mortgage interest deduction being removed and that is not going to happen.


What happens, if you own a house, if it’s your primary house, even a second house right now, you can deduct all the interest you pay on your mortgage up to one million dollar mortgage from your taxes, it’s a huge advantage for homeowners. What’s going to happen is, that will stay the same or at least similar there’s one version that would reduce that from a million dollar loan to a half a million dollar loan, however, this deduction will not become nearly as big of a deal as it is now because at the same time they are doubling the standard deduction for people.


So, right now there’s a standard deduction so people can just take this deduction of 6700 dollars for one person or something like that, $12,000 for a couple, off their taxes if they don’t want to itemize every single expense they have. So, if you take the standard deduction you do not take off the interest from your mortgage, you just take the standard deduction it doesn’t matter what other deductions you take. There’s just one standard deduction you take, well, they’re going to double the standard deduction so instead of a couple having $12,000 is going to be $24,000 standard deduction.


So, what that’s going to do is more than 90% of people will be better off just taking the standard deduction than itemizing their expenses. So, you’ll still be able to itemize the mortgage, interest, on your house but it won’t make sense for most people to do it so it will be not as big of an advantage for 90% of the population to buy a house. What does that mean for the real estate market? Well, the National Association of Realtors feels it will destroy the market and cause mass chaos.


I don’t think it will destroy the market, I think it will definitely affect it, it could definitely cause more people to become renters and buyers which will cause weakening in the whole market. How much? Who knows? I think there will still be a lot of people who buy houses just because they want to buy houses. There is still a ton of advantages of buying houses if we do it the right way. But, at the same time a lot of people don’t do the research, they don’t really look at the advantages versus the disadvantages they just listen to what other people say and if more and more people say, “Hey, renting is better than buying”, more and more people start renting instead of buying houses which could drastically affect the housing market.So, that’s something to look out for, for sure.


Something else to change for homeowners is, looks like both bills, they’re going to max out property tax deduction at $10,000 a year which will hurt high-end houses and people in high property tax states like New Jersey, New York, Illinois, that will increase taxes for those people as well. You also will no longer be able to deduct interest from home equity loans. Right now it can jump up to a $100,000 in home equity loans that will be going away which is another increase in taxes for home owners.


The absolute biggest change which will affect people the most is a tax free gain from selling a personal residence. So, right now if you live in a home, for two to the last five years you can sell it, take up the $250,000 individual or $500,000 it’s couple tax free profit. So, this is a huge advantage of real estate, you can live in a house for two years, make $200,000 on it, sell it, not pay taxes on any of that money. Well, they are changing that law so instead of, you have to live in the house for two out of five years, you have to live in the house for five out of eight years.


So, that’s a huge change that will affect a lot of people and that will go in to effect almost immediately so that you have to sell your house in 2017 or have it under contract in 2017 depending on which version the bill passes to still qualify for the two out of five years. So, as real estate investors, maybe there is some opportunity to buy houses really fast before the end of the year from people who want to take advantage of that, otherwise that could be a massive tax liability that many people are   sell with that they didn’t have before. If you live in a house for three years and make a $100,000 on it, you’re paying 20 to 40 thousand dollars in taxes on that profit where before you would pay nothing.


So, it’s a huge difference, I don’t know how they’re going to account for that, are they going to make people save that money until they pay their taxes. Are they going to take that money out of closing and hold it for them, I can see this causing a lot of problems, really hurting the real estate market and causing all tax issues and people be behind on their taxes if they’re forced to save that money for, you know, a few months or even a year until they have to pay that huge tax bill. So, that is a massive change we all need to be planning for, figuring out and, who knows exactly how that’s going to work out in the long run but it will make buying a house much less advantageous than it was before.


People will probably move much less, they’ll stay in their houses longer, that could decrease the market prices, that could decrease house building, all kinds of things could be affected by this. So, this tax bill probably will hurt the housing market, how much is hard to say. Why are they doing this? I hate to get political but I will have to a little bit, is because they’re creating massive tax decreases for corporations and other people that they have to pay for and it appears to me as the way for them to pay for those other massive tax cuts is to tax homeowners more, and it is estimated that by changing the tax laws on real estate, on houses, that I just discussed it will add a trillion dollars in revenue over the next ten years.


And, with the current tax bill that they’re trying to pass, the law states, they cannot add to the deficit by more than 1.5 trillion dollars in ten years. And with, the bill the Senate passed, it’s estimated they will increase the tax bill like 1.47 trillion dollars over the next ten years so they had you save money in some places in order to pay for this big tax breaks in other places and homeowners, kind of got the short end of the stick on this deal. So, we’ll have to see how the final bill comes out but both the Senate and the house bill seem to agree on almost all of these points, almost 100% there’s a few small differences but nothing crazy.


So, homeowners will definitely be coming in to some huge differences on paying taxes and yeah, I guess we’ll see what happens. The other thing to think about NAR, National Association of Realtors, came out with some statistics on tax savings for people because of these rules they are saying that people who make from 60,000 to 300,000, basically whatever the middle class is, will save money renting a house versus owning it because of the tax laws. For example, someone who makes a $120,000 if they are renting a house they might save 34 hundred dollars a year in their taxes with the new bill, awesome, that’s great.


Of course, people have to save money on their taxes. However, a homeowner if you own your house you might actually pay $200 more in taxes a year with the new bill. So, that’s a 36 hundred dollar difference that you’re paying in taxes based on if you’re a renter or a homeowner. Huge difference there and that’s why NAR thinks it’s going to hurt the real estate so much. Again I don’t think most people are going to be doing the analytics and really scrutinizing how much you’re going to pay in taxes versus renting and buying but there will be enough people out there jumping on saying that people should rent not buy.


I mean, that’s really a huge push out there for people to rent and not buy already which I think is silly. It’s much better to buy, but this could increase that sentiment even more. How about real estate investors? How are they going to be effective? That is something that is completely opposite. Real estate investors will have huge advantages with the new tax bill. I myself will have huge advantages with the new tax bill. Why?


Because of the way corporations are taxed is going to change the way real estate investors pay taxes, there are also other specific changes to real estate investing, there’ll be huge advantages for people who are landlords or flippers and it will cause us to pay much less in taxes than we pay right now. One of the biggest things that will change is — what’s called ‘pass-through income’. So, if you have an LLC, an S Corporation, some other types of corporations, basically it’s a pass-through corporation where the LLC makes money, that money is passed through the individual, the individual pays taxes on that money based of their ordinary income rate.


So, if you’re on the highest tax rate right now you pay 39.6% tax rate on money that passes through your LLC, passes through your S Corporation, there is basically no advantage to having that LLC or S Corporation for tax purposes. There’s other advantages but for taxes you’re still paying earned income rates of whatever your tax bracket is. Well, the new tax bills will change that. Instead of paying 39% or 35% or whatever your rate is, you would pay 25% on pass-through income. That’s a savings of almost 15% a year for the highest income earners who have most real estate investors using LLCs as corporation things like that.


Those highest income earners going to save 15% a year in their taxes assuming this goes through. There could be some restrictions, the senate bill has some restrictions for those who make over 700,000. The house bill does not so we don’t know for sure how that will work out but for sure it looks like people will be paying less taxes when they have S corporations or LLC’s.


Another thing is the depreciation schedules are changing for rental properties. So right now if you have a residential rental property you can depreciate it over 27.5 years. That means the value of the structure of your property can be divided by 27.5, you can then depreciate that each year from your taxes, save you thousands of dollars a year in depreciation.


Well, that is being decreased from 27.5 to 25 years. So the advantage there you can depreciate more money, save more money, each year on your taxes. The big huge change is it -for non-residential properties the depreciation schedule right now is 39 years so it will depreciate the property over 39 years you get small depreciations each year than residential. That is being changed to 25 years too, huge advantage for people who own commercial properties. Often, big multi-million commercial properties could be saving tens of thousands of dollars a year on taxes because of this change.


I mean, that’s absolutely crazy how much money people will save each year by depreciating the properties from 39 years to 25 years. That’s a massive change will help a lot of people save a lot of money. Something else, landlords will still be able to deduct the interest from their mortgages on the rental properties in full, nothing is changing there really, it’s almost all good news for real estate investors as opposed to homeowners. Again we don’t know exactly how it will play out exactly how it’ll read but for right now it’s looks like investors will be saving a ton of money on their taxes, homeowners will be paying more money on their taxes and how that plays out is less homeowners, more investors, more renters, less people owning their home.


Now, is that a good or bad thing? Well, I guess it depends on how you look at the economy. The tough part about this is most people make almost all of their net worth from their house. Now in a perfect world, everybody would save money, everybody to invest money, they’d have rental properties, they’d have money in stock market however you want to do it. Most of their net worth would be investments. That doesn’t happen most people spend everything they earn. What is happening with housing is an incredible way to force people to save money.


So, I got a cool chart in my other article I wrote but basically it says if you’re 35 to 44 years old, 59% of your net worth is in home equity so more than half of your net worth is in your home equity if you’re 35 to 44. As you get older that jumps to 70% for 45 to 54 years old, it actually drops a little bit to 68% for 55 to 64 year olds, but then 65 to 74 year olds, 80% of your net worth is in your home. So, if we’re encouraging more people to rent than buy we’re basically decreasing the net worth of most people, they’re going to be worse off financially have less money to spend in the economy and to me, you know, those people are spending every dime they have, if they have less money to spend, that is money coming directly out of the economy.


Where big businesses is, if they’re getting tax breaks, if they have more cash there’s no guarantee there’s spending money directly on the economy. In fact there’s a good chance they will be pocketing that money, buying back shares, paying more dividends, and not investing in the economy. So, it’s, kind of tough to know exactly what will happen like I said a lot of times but it does not look good for homeowners for the average person, the really crazy statistic shows that people who own their home have 44 times the net worth of people who rent a house.


You know, there are other factors in there, like most people who own a home probably make more money. Most very, very, wealthy people almost all of them own their home. But in general, if you own a house you have much more net worth, be much better off than if you rent. And this bill encourages rent, encourages people not to own their own house. So, in the long run, you know, we have to see what the final bill is, what it says, if you’re a real estate investor, awesome, you’re probably in really good shape, you going to make more money. If you’re a homeowner, not so great, you have to pay more taxes, you have more complicated taxes if you sell a house and you don’t live there for five years.


There is just a lot to consider so we’ll see exactly how everything shakes out, how it all becomes official in the next few weeks probably. I think the President had said he wants to get these all signed and done before Christmas so everything can take effect the next year, but we’ll see, and one another thing to consider too is that, while many of these tax disadvantages for homeowners will take effect almost immediately, the tax advantages for investors and corporations may not take effect until 2019.


So, it might not be next year that you have all these advantages but the year after and, you know, there are some funny math being done I’ll just go over that real fast, like I said. The changes to the home owner tax rules will probably add a trillion dollars of revenue to the budget. That will help make up for all the tax cuts we’re doing for corporations and pass-through. So, for corporations they are reducing the tax rate from what is now 35% to 20%, which means there will be much less revenue coming in and in theory the economy will do better, will make up for that revenue, however all the studies done have shown that the economy will not do good enough to come close to making up for that revenue.


So, we’ll still have this big deficit. A lot of these tax changes, advantages, expire in 2025 because the deficit can now increase by 1.5 trillion, more than 1.5 trillion, in the next decade so they have to stop these tax breaks in 2025 to stop the deficit from increasing passed 1.5 trillion.


So, there’s a lot of funny things going on, lot of crazy things going on, with this bill. Where to me it’s very short term, very short sighted, it hurts a lot of the middle class and people who own houses. It helps people who are wealthy, tremendously, it will lower most of their taxes by a lot because most of them have corporations, get their money through passive income, through pass-through corporations where they will be saving a lot of money in their taxes, people who have earned income wages, who own houses, will not be saving hardly anything or possibly even paying more on their taxes with this current bill.


So, like I said, we’ll see what happens, we will see where it goes but, for right now, be ready for some big changes on both fronts, investing and home owning and l we’ll have to see the final bill comes out to be and how it affects the housing market. I think it will definitely negatively affect it, how much? We have no idea, I don’t think it’s going to drop 10% like the National Association of Realtors thinks but it could definitely cause a slowdown, cause people to want to sell their houses quickly at the end of the year, if they can, and make it less advantageous for people to buy instead of rent.


Alright, thank you for listening, we’ll have another podcast next week of course and be sure to leave any comments, questions, below the post of the show notes. Alright, take care and we’ll talk soon.



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