Written by Joe Ran
REPOSTED DIRECTLY FROM INMAN NEWS. THIS CONTENT HAS NOT BEEN MODERATED BY UTAH INCOME PROPERTIES, LLC.
President Trump and the Republican congressional leadership have proposed a new tax bill. The bill consolidates some income tax rates, lowers the corporate tax rate, reduces the tax rate for certain pass-through businesses, eliminates the estate tax and takes away many long-established deductions and exemptions.
Sounds great, right?
Well, it’s terrible for housing. Really terrible.
Now, I’m not making a political statement here. I’m not writing as a Democrat, or a Republican, a BernieBro or a tea party patriot.
I’m just writing as a real estate industry professional. And I’m writing to other real estate professionals to say — this bill is really bad for you and your clients, and you should be doing everything you can to fight it.
It’s almost a joke, a pastiche of anti-housing policies, a ghastly tapestry stitching together a patchwork of terrible ideas that are going to severely depress real estate markets across the country at a time when homeownership is already at a historic low of 63.9 percent.
Why? Well, it’s bad enough that the tax bill will negatively impact property values by reducing the mortgage interest deduction, changing the capital gains extension on residences, capping property tax deductibility and some other terrible stuff. That’s bad for homesellers, homebuyers, homeowners — and us — because what’s bad for all of them is usually bad for us.
But even worse than that, the new bill actually makes it more expensive to move! And that’s not good. We want people to move. We make our living when people move.
So we need greater motility, not less. Indeed, most of the markets in this country need inventory because homeowners with historically low interest rates already have a lot of incentives to stay put and hold on to those rates.
But this bill is going to hurt housing in a lot of ways.
Let’s count them:
The bill reduces the value of the mortgage interest deduction — but for new buyers only!
The tax bill lowers the mortgage interest deduction cap from $1 million to $500,000, which will particularly impact people in high-priced markets (and luxury buyers elsewhere in the country). Owning a high-priced home is going to be a lot more expensive under the new law.
Now, I get that the mortgage interest deduction is not the most economically efficient housing tax policy. It’s regressive, helping only wealthier taxpayers because most lower-income homeowners take the standard deduction rather than itemize.
It doesn’t necessarily incentivize homebuying, it just encourages people to buy larger houses. I know all that. So if Congress wanted to get rid of the mortgage interest deduction entirely, I wouldn’t love it, but I could live with it.
But the new bill does something really, really stupid — it puts the $500,000 cap on new buyers, but keeps the $1 million cap for existing homeowners. On its face, it’s an attempt to be fair, to help current homeowners preserve a tax break they depended on when they bought their home.
Think, though, about what that does for motility — the rate at which people move. If I own a home with a mortgage between $500,000 and $1 million, I can now deduct all my mortgage interest.
But if I sell my home and buy something else that’s the same price, or more expensive, I’m not going to be able to deduct as much of my interest as I do today.
So why move? I’ve probably got a great rate. I can deduct maybe all of my mortgage interest. And most of my payments for the next 10 years or so are interest payments.
So I stay put. And that person who would have bought my house stays put. And the person whose house I would have bought stays put. And the agents we would have all hired? They don’t make any money.
In other words: bad for sellers, bad for new buyers, and bad for agents and brokers.
The bill requires people to say in their homes longer to get the capital gains exemption.
Tax law has long helped homeowners and facilitated motility by allowing them to exempt the capital gains on their primary residence. If you’ve lived in your primary residence for two of the past five years, you can exempt up to $250,000 of your capital gains ($500,000 for married couples filing jointly).
So what does the new tax bill do? It makes you stay in your home longer — you have to own and live in the home for five out of the last eight years. On top of that, you might not even get the exemption if you make too much money.
Now, I get that most people aren’t lucky enough to generate more than $250,000 of capital gains by living in a home for just two years. So I’m not sure how many people this will affect.
But that’s sort of the point. How much money could we be saving by requiring someone to live in a home for three extra years in order to claim the exemption? Why should it matter? And if it’s a small amount, why put that disincentive to moving in place?
The bill makes homes with high property taxes much less attractive.
Currently, the federal government allows you to deduct your state and local taxes and your property taxes from your federal tax bill. That makes sense, insofar as it feels unfair to tax you on money you already used to pay your state and local taxes.
But that’s changing with this new tax reform, which eliminates the deduction for state income taxes — and puts a $10,000 cap on deductibility of property taxes.
Now, for some people, this might not be a big deal. Depending on where you live, you might be thinking, “well, that should be enough, what kind of idiot would buy a house with more than $10,000 in property taxes?”
Two thumbs pointing at this guy. And at everyone who lives in my neighborhood, county, and frankly, region.
I pay a lot more than that every year in property taxes. I’m not going to tell you how much because it’s embarrassing. But I live in New York, which has some of the highest property tax rates in the country. So it’s something I deal with, both as a homeowner and a real estate professional.
Maybe you’ll discount this because you live in a low-tax state, and you won’t be impacted. But for a lot of people, this change makes it much more expensive to own your own home. And that’s not good for housing generally.
The bill eliminates the deduction for moving expenses.
OK, this is a small thing, but it’s just adding insult to injury — the bill eliminates the deduction for moving expenses.
Right now, you can deduct expenses if you’re moving for a new job or a transfer for your existing job. This may not seem like a big deal, but when your move costs you upward of $10,000, that might mean a deduction worth $3,000 or $4,000.
No, it’s not going to make the difference between someone moving and not moving, particularly if you get transferred or take a new job.
I don’t think many people are going to decide to stay put because they can’t deduct their expenses anymore. But it’s just another example of how this new bill depresses the incentive to get a new home.
The bill makes second homes and vacation homes much more expensive.
If you work in a second-home market, realize that this bill just reduced the value of every home in your market.
Why? Well, figure that anyone buying a second home is probably in the 39 percent tax bracket (otherwise, they most likely can’t afford a vacation home).
So let’s say they are buying that $1 million beachfront home, getting an $800,000 mortgage.
At today’s rates, they’ll pay about $5,000 per month as a mortgage payment, most of which (at least for the first few years) will be interest. Thus, if they pay $60,000 per year in interest, they get a deduction of about $24,000, which means their effective payment is $36,000 a year.
Now, under the new law, they can’t deduct that interest. So maybe they can no longer afford $60,000 a year in second-home payments. If they can only afford that effective $36,000 per year that they were paying under current law, their buying power just got slashed by about 40 percent.
Maybe they’re rich enough, or they’re getting a tax break in this bill in some other way that allows them to buy that same $1 million home even without the tax deduction. So maybe you won’t see a big hit in your second-home prices. But maybe you will.
Don’t own, invest!
Here’s what’s also kind of strange — on top of all these disincentives to buy or sell a home, the tax bill simultaneously creates or preserves a number of advantages for owning investment property. In other words, the tax bill is bad for homeowners but not for real estate investors. Odd, right?
Here’s what I mean:
First, real estate investors can still deduct the interest on their loans and property taxes without any cap. Homeowners can only deduct their mortgage interest up to $500,000, and property taxes up to $10,000, but there’s no cap for investors.
That’s because investment property deductions for interest or taxes are not itemized deductions. Rather, they’re deductions in computing net rental income.
Indeed, the tax bill specifically exempts real estate investors from a new 30 percent limit on business interest deductibility, so it’s especially favoring them compared to other business owners.
Second, the bill preserves many other tax advantages for investment real estate: the deductibility of maintenance costs and depreciation, the like-kind exchanges and so on.
Third, one of the major tax changes in the bill — conferring a 25 percent tax rate on so-called “pass-through businesses” — could reduce the tax rate for passive real estate investors who buy and manage buildings through LLCs or partnerships, which is almost all of them.
Now, I have no problem with maintaining or improving the tax advantages for investment real estate. That’s great. I just don’t get why the new law should be so bad for the residential real estate market and at the same time be so good for the investment real estate market.
OK, let’s sum it up.
The new tax bill is only bad if you’re a:
I don’t know … that seems like a lot of people.
Finally, you might say, “well, this might be bad for me personally, but I’m a patriot, so if it’s good for the country I’m for it!” OK, I get it. I agree. I’d be willing to make sacrifices if I felt that they went to the common good.
But why are we the only ones who have to be patriots? And why are we making sacrifices for all these other people, who seem to be doing pretty OK right now:
Yes, you could argue that, depending on their personal situation, certain middle-income taxpayers might get a small tax cut, maybe a few hundred dollars.
But on balance, they’re not going to come out ahead if they’re homeowners, or buying a home, or selling a home, or working in the real estate industry.
Again, this is not about politics. I’m not saying this tax reform is bad for housing because it’s a Republican bill. When President Obama and a Democratic congress passed the Home Buyer Tax Credit in 2008, I was highly critical of a number of its restrictive provisions.
I do politics on my own time. When it comes to my day job, I only care about the facts and how they impact my industry, my business, my workforce and my clients.
And the fact is this is not a good tax bill for real estate and housing.
Joe Rand is the chief creative officer of Better Homes and Gardens Real Estate — Rand Realty, a real estate brokerage in New York City’s northern suburbs, and the author of the forthcoming book Disruptors, Discounters, and Doubters: Five Changes the Real Estate Industry Needs to Make for a Client-Centric World.
The views and opinions of authors expressed in this publication do not necessarily state or reflect those of UTAH INCOME PROPERTIES LLC, or its affiliated companies, or their respective management or personnel.
Find an Agent that Understands Investment Properties
Finding a real estate agent that is familiar with investment properties is not as simple as finding a realtor to buy or sell a residential home. Real estate investing works under a different set of standards than buying or selling a home to live in, and it requires particular knowledge and a set of skills that not every Realtor possesses. If you are considering real estate investing, you need to find the right agent and the right area to begin your investment search.
Often, a successful investor's agent is also a successful investor themselves. They understand the drive behind investing and will understand your incentives. An investor-oriented real estate agent should be able to provide in-depth knowledge and tips to help you succeed in making a profit, such as being able to predict shifts in the market and guide you in the right direction.
Can They Help You Achieve Your Investment Goals?
When buying an investment property, outline your criteria. For instance, are you interested in older properties to fix up and hold/flip in class B/C neighborhood? Or are you looking for something new in class A/B neighborhood? Testing an agent’s knowledge on these types of investments is another way of knowing if they are right for you. Ask the agent what types of properties they have worked with in the past and what they are most comfortable handling.
Related: How to Identify A, B & C-Class Areas (& How to Know Which You Should Invest in!)
Related: Class A, B, C & D Real Estate: How to Know Where YOU Should Invest
A great investor's agent knows where to find deals that are not open to public, and how to get them. They know how crucial it is for an investor to have a team of experts on their side to make it happen. Look for an agent who has strong connections with reliable local experts, such as builders and developers, lenders who specialize in investment financing programs, CPAs, escrow companies, 1031 Exchange Intermediators, eviction law specialists, and so on. A great investor's agent can also make the course of investing much less complicated and frustrating.
How to Choose an Expert for Your Needs
As an investor, you need an agent by your side that you are comfortable with and is able to cater to your specific needs. Since making a profit on investment properties often requires making lower offers, an agent must be comfortable with serious negotiating. A great investor's agent also knows the market trends, demand and supply well enough to be able to make an appropriate offer so that you are not chasing the seller away unnecessarily. Also, make sure to choose an agent who has a good communication skill. Choosing the right investor's agent is vital to achieve a successful investment. Their job is to basically become the team leader of your investment plans, and that includes looking over every aspect of your real estate investments, not just the purchase/sale transaction process, and to make sure that you are making the right move, every step of the way.
Find an Agent that Understands "Cap Rate" & "Cash Flow"
An agent that understands investment properties will be able to calculate and find you the cap rate of properties. Getting a return on your investment is your sole purpose; your agent needs to assure you that you are spending your money wisely. Make sure the agent is capable of calculating cash flow. If you are planning on renovating your investment property or flipping the property, the agent should understand after repair values and have comparable comps in the same neighborhoods.
Related: What is Capitalization Rate?
Related: What is Cash Flow?
Find an Agent that Understands the Local Market
It is extremely important to choose an agent who knows your local investing market. No matter how well they know about Cap Rates and Cash Flow, it means nothing if they don't understand the uniqueness of the specific market you are after. They should understand the shifts in the real estate market you’re in and how that will influence the value of your investment property. A real estate agent that is comfortable with investment properties needs to understand the micro-markets, especially in a unique market like Utah. Understanding which neighborhoods work best for the purpose of investing is also critical.
What is the Cost of Working with An Investor's Agent?
When you are buying an investment property, the answer to that is ZERO. What it means is that investor's agents typically work as a buyer's agent, and their commission is paid by the seller of the property. Typically the commission the seller pays is 5-6% of the purchase price, and is split between the listing (seller's) agent and the buyer's (investor's) agent. So as long as you are the buyer, it costs you nothing to be working with an investor's agent. If you are selling a property, then you will be responsible for whatever the commission amount you and your agent agree on.
One of the advantages of hiring an agent who specializes in investment properties to sell your porperty is that they could market your property to an entirely different market than the home-buyer market; An investor-oriented agent is more likely to have other investor clients that are actively looking for investment properties to buy. They may also have a wide network of other investor-friendly agents with active buyers.
How To Find The Right Agent?
When looking for the right agent, the best method is by word of mouth. Ask fellow investors if they know local agents that have experience with investment properties. Check your local business agency to find real estate agent offices and search their ratings. Do not be afraid to ask the agent for names of their investor clients that they have worked with. If they have been successful with investment properties in the past, they should be willing to share positive references!
Utah’s population crossed the 3.0 million mark as it became the nation’s fastest-growing state over the last year. Its population increased 2.0 percent to 3.1 million from July 1, 2015, to July 1, 2016, according to U.S. Census Bureau national and state population estimates released today.
“States in the South and West continued to lead in population growth,” said Ben Bolender, Chief of the Population Estimates Branch. “In 2016, 37.9 percent of the nation’s population lived in the South and 23.7 percent lived in the West.”
Following Utah, Nevada (2.0 percent), Idaho (1.8 percent), Florida (1.8 percent) and Washington (1.8 percent) saw the largest percentage increases in population.
In December 2016, we bought a small brand new fourplex in Provo for $550K. Our straight line depreciation amount would have been $700. After using a combination of powerful tax saving techniques, we were able to bump it up to $98,000, with a very little cost. Here's how we did it.
Read the previous article - Part 1: Bonus Depreciation
#2 - Cost Segregation
Whether you own a fourplex, an apartment building or a hotel, there are substantial tax savings that are hidden beneath your feet, within the walls and even in the landscaping and paving outside your building. By doing a cost segregation study, you can:
We invited our trusted cost segregation expert Brett Hansen from Cost Segregation Authority who have been a tremendous help to us and our clients to explain exactly what cost segregation is, and how the process works and how it could benefit you.
WHAT IS COST SEGREGATION?
Cost segregation is a highly beneficial and widely accepted tax planning strategy utilized by commercial real estate owners and tenants to accelerate depreciation deductions, defer tax, and improve cash flow. Once used only by big-4 type accounting firms and the nation’s largest real estate owners, this practice has now become routine for commercial property owners of almost every size.
A Cost Segregation Study (CSS) is based on a detailed engineering-based analysis that is used to support the acceleration of depreciation deductions by identifying costs that can be allocated to shorter recovery periods; primarily 5, 7, and 15-year, as opposed to 27.5 (residential) or 39-year (commercial).
A quality study provides the documentation needed to defer substantial tax payments and greatly improve cash flow. It is important to note that a cost segregation study does not create new deductions, but increases deductions in the early years of ownership. This front-loading of depreciation allows the taxpayer to take advantage of the time value of money.
Cost Segregation is applicable to ANY income property, including leaseholds and can be applied retroactively to any building purchase or construction back to about 1987.
By increasing your depreciation deduction, you reduce your taxable income resulting in lower tax payments. Smart developers and investors use this savings to reinvest in more properties. See apartment example below:
For property that is constructed (original use) and has an asset life of less than 20 years, a congressional stimulus inducement known as Bonus Depreciation will apply allowing you to take 50% (thru 2017) additional depreciation in Year 1. See example above. This is being phased out through 2019 so now is the time to take advantage.
By having your building costs segregated, an investor can now allocate the sales price of the asset to the land and structure (appreciable components) and reduce the recapture on personal property (i.e. carpet) that was not sold at a gain.
Cost Segregation and 1031 Exchanges work hand in hand to further defer the payment of taxes.
The chart below shows the industry average reclassification of total capitalized costs based on asset type.
Each study is priced according to its cost, size, complexity, location and other internal factors. These prices range anywhere from $2,000 to $200,000 or more depending on the investor/developer’s portfolio.
On average, a single, 4-story building study with moderate complexity will run about $15,000. The IRS prohibits pricing based on tax savings, but we do like to see at least an 8-10x return on the cost of the study whenever possible.
We will always run a benefit analysis on the property at no cost to determine if the cost segregation study is appropriate and provides enough benefit. About 95% of the time it does.
Cost Segregation Authority
A real-life example: a brand new fourplex built & placed in service in December 2016