Next up in Washington will be tax reform since an easy, no-brainer like infrastructure improvement has been put on hold until sometime later in 2018. Fixing roads and bridges awaits the findings of the new committee formed to study the subject — which really means a fight over which states deserve to receive the forthcoming pork.
Where was I? Oh yes. Tax reform. But first, I’ll note that one aspect of returning to a summer home for vacation is that all the magazines lying around are from July and August of the previous year. It’s interesting to read articles relating to the presidential candidates and place myself in the mindset I harbored in the summer of 2016. From there, knowing what has since happened is like being in a time machine.
Several 2016 articles offered speculation involving our president’s tax returns, which would be released as soon as his IRS audit was completed. What was clear without seeing the returns is that real estate offers vast opportunities to shelter income and profit — indefinitely. It will be interesting to see what tax reform’s proposals will offer as a way to bring real estate taxation into line with other asset classes.So we know how commercial real estate taxation is unfair to those of us investing primarily in retirement plans, let’s start counting the ways.
First, there is depreciation — meaning that buildings lose value based on a schedule and the loss can be deducted from income, even though the buildings themselves are actually appreciating in value in most cases.
Second, interest on loans and taxes is an expense, which can also be written off against rental income. Not a problem necessarily, except that while borrowing on common stocks has legal limits, real estate presents no such limits. Unfair!
If you make a profit when selling a building, the profit is not taxable if you roll the money forward into another “like-kind” investment — meaning more real estate of almost any type.
Finally, a real estate investor is deemed to be an active real estate professional if half of their time is spent in the business. Real estate paper losses can then be applied to all the other income they have — income that may not be remotely related to the real estate holdings.
President Donald Trump, back in the middle of the 2016 campaign, was apparently making the case that half of his time was still spent running his company — a questionable “toe-hold of rationale.”
Following the example set by the president, we may see a broader application of what may become the “loophole for the little guy.” Example: A retired senior with just a few residential income properties could make the case that half of his or her professional time was spent in property management. The result would be paper losses that could more than offset other income from whatever source it was derived — while the houses appreciated in value, tax free.
If we think tax reform will tamper with any of this, let’s not hold our collective breath. The jungle tom-toms are now suggesting limits on tax deductions that currently benefit more typical Americans.
It will be interesting to arrive next summer and see how much of this summer’s tax-reform speculation will have become reality.