Understand the New Tax Law: Video 4 (Real Estate Professionals)
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Understand the New Tax Law: Video 4 (Real Estate Professionals)


My name is Evan Liddiard of the National Association
of REALTORS®. Welcome back to our video series on what you
need to know about the new tax law. In this segment, we will explore a couple
of business tax changes for those who are self-employed. These apply to a high percentage of those
who make their living helping people buy and sell real estate. Joining me again is Peter Baker of the Business
Planning Group. Peter has decades of experience helping REALTORS®
and real estate businesses with their taxes. Great to be back, Evan. Today we have just two provisions to go over,
and they contrast with each other. The first is a new and pretty significant
tax deduction for most of you, while the second is a small and annoying repeal of an old partial
tax deduction. So, one is big and welcome news. The other is bad news but is much smaller
in importance. You may have heard a little bit about both
of these changes, but perhaps you do not know how or if they apply to your own situation. Peter, it’s like the old saying, we have
some good news and some not so good news – which do you want first? Let’s start with the bad news, Evan, then
we can end this video on a very positive note. Good thinking, Peter. Our first provision is a cutback in the deduction
for business entertainment expenses. This is something on which many REALTORS®
spend at least some money every year. Up through the end of 2017, if a self-employed
real estate professional took a business contact out to a ballgame or other entertainment event
that either preceded or followed a business discussion, then 50% of the cost of the entertainment
was deductible as a business expense. A similar rule also applied for a meal where
business was discussed – 50% of the cost was deductible. However, the new tax act changed this by repealing
the 50% deduction for all entertainment expenses, even if they are related to a business discussion. This was effective as of January 1, 2018. Fortunately, the 50% deduction for business
meals was retained. Peter, this sounds pretty straightforward. How big of a change is this and is there anything
else our viewers need to know? As you said, Evan, for most taxpayers, this
is more of an annoyance than a big dollar item. Yes, many REALTORS® will have slightly lower
deductions, and that is never good, but maybe just as irritating is the fact that this is
just one more change, one more bookkeeping entry, to have to deal with. Until recently, there were some unanswered
questions about how this change was really going to affect business people. For example, suppose an agent named Randi
Realtor were to take her business contacts Bob and Bev to a baseball game. She not only paid for the tickets but also
buys hot dogs, soft drinks, and ice cream for all three while watching the game. How is this going to be treated – as a meal,
which is still partially deductible, or as entertainment, which is now non-deductible? In early October, the IRS released temporary
guidance, which tax filers can rely on until the final rules come out, likely later this
year. The guidance makes clear that in cases where
both food and entertainment is present, the cost of the food is still 50% deductible if
it is purchased separately, or if the cost of the food is set out as a separate line
item. So, in the case of Randi, the cost of the
tickets is not deductible. However, since she paid for the food separately,
she can deduct 50% of the food cost. What if Randi took her guests to one of those
nice stadium suites, where food is available? Doesn’t part of Randi’s cost represent
the food? Yes, but unless the cost of the food is set
out as a separate line item, then all the cost will be allocated to entertainment and
none of it will be deductible. One situation I hear about from NAR members
is when a Realtor hosts a reception for clients and potential clients and offers food. This is not exactly a business meal and it
isn’t really entertainment either. Peter, how do you think the temporary guidance
applies to this situation? Although the new guidance does not specifically
say so, I would advise my clients to plan to take a 50% deduction for any food they
purchase for business meetings or receptions like this, or for open houses where they host
potential clients. Well, that was not so painful, was it? And now we can move on to the good news, which
is much bigger. What is this new deduction I mentioned? It goes by several different names but probably
the easiest is the “Deduction for Qualified Business Income.” But you also might have heard it called the
“Pass-Through Business Deduction” or the “199A Deduction,” which refers to the
section where it is found in the Internal Revenue Code. This is a deduction of up to 20% of certain
business income of sole proprietors of businesses, such as independent contractors, and for owners
of so-called pass-through businesses. I think understanding the deduction might
be a little easier if we first talk a bit about why it was included in the new tax law. As tax reform bill was being developed in
Congress last year, there were many ideas that were discussed as being key parts. But the most essential element and centerpiece
was a huge reduction in the corporate tax rate – a drop from 35% all the way down
to 21%. Making such a big change has lots of implications,
both in and out of the corporate world. Not all business activity takes place within
regular corporations. Indeed, more than 90% of all of America’s
business entities are not regular corporations. Instead, they are organized as partnerships,
limited liability companies (LLCs), S corporations, or most common of all, just plain old sole
proprietorships. These businesses have one thing in common,
and that is they report their income on their owners’ individual tax returns. In fact, these businesses do not directly
pay taxes at all. Instead, the tax liability is passed through
to the owners. There were two big concerns about drastically
cutting the tax rate only for regular corporations. The first was political – what kind of signal
to Main Street America would be sent if the new law only cut taxes for the big boys, but
not for the millions of smaller businesses? This is not a good way to win friends if you
are interested in reelection. The second problem was more practical. What was to stop all these millions of small
businesses from changing their status by incorporating to take advantage of these lower tax rates? Thus, the architects of the tax bill knew
that if they were going to include a big tax rate cut for corporations, they had to also
put in a similar tax cut for these pass-through businesses too. But this was a real problem, because unless
there are certain safeguards in place, what is there to stop regular wage and salary earners
from simply becoming independent contractors rather than employees and cutting themselves
in on the action? In the end, the provision that survived was
a big surprise for most of us – a 20% deduction from net business income. This was much higher than was featured in
earlier versions. And another surprise was that the deduction
was available to all kinds of services businesses with incomes below certain thresholds. So, let’s get into some details. This can be confusing because it is a brand-new
concept. It is important to note that the new deduction
is not an itemized deduction. Nor is it a typical business deduction that
is based on an expenditure. Rather, it is an across-the-board deduction
from net income that is computed after other expenses have been factored in. The next thing to know is that the general
rule of the new provision limits the deduction to non-specified service businesses. Well, what are these? This is tax law parlance for businesses in
the following fields: “any trade or business involving the performance
of services in the fields of health, law, accounting, actuarial science, performing
arts, consulting, athletics, financial services, brokerage services, investing or investment
managing, trading, dealing in certain assets, or any trade or business where the principal
asset of such trade or business is the reputation or skill of one or more of its employees.” You may be thinking that most real estate
professionals are going to be classified in the definition of a specified service business. And this is what was expected. But there is lots of good news here. And it has gotten even better with the recent
release of guidance from Treasury and IRS. Peter, what is the first bit of good news? A major exception was added right before the
bill was enacted that allows almost any pass-through business owner with less than a certain amount
of taxable income to still take the deduction, despite their being in one of these specified
service businesses (SSB). The exception provides that if the business
owner has taxable income of less than $157,500 as a single taxpayer, or $315,000 as a married
couple filing a joint return, then the restriction does not apply. In other words, everyone who has qualified
business income will be able to take the deduction, so long as their taxable income is below these
thresholds. And for those with income above these amounts,
there is still hope. There are phase-in ranges of $50,000 for singles
and $100,000 for joint returns. Over these ranges, the deduction is ratably
phased out. If this sounds confusing, you are in good
company. But we are going to cover some examples in
a few moments that should help clarify. Now, for the second bit of good news. Take another look at this list of service
business fields, which are prohibited from claiming the 20% deduction if their income
is over the thresholds. When preliminary guidance came out in, it
specifically said that real estate is not included in the term “brokerage services.” Instead, this term was limited to the brokerage
of stocks and other securities. This big win for the real estate was at least
partly the result of a huge effort by NAR in urging Treasury and IRS to remove real
estate from the list. To sum up, the first exception allows all
real estate professionals with income below the thresholds to claim the 20% deduction. And the recent guidance says that even real
estate agents and brokers with income above the thresholds will be eligible for a deduction
of up to 20%, according to a formula. This formula provides that the 20% deduction
is available, but is limited to the greater of:
1) 50% of the W-2 wages paid by the business, or
2) the total of 25% of the W-2 wages paid by the business plus 2.5% of the original
cost basis of the tangible depreciable property of the business at the end of the year. Confusing, right? Hopefully you can see that in order to get
a deduction if you are over the taxable income thresholds, to qualify for any deduction your
business will need to either pay (W-2) wages to employees, or own depreciable property,
or both. It might be best if we try to explain this
using some examples. In this first example, we are looking at a
fairly average Realtor named Amy Agent. She has net commissions of $67,000 for the
year, after deducting all of her normal business expenses. The first thing to notice is that unlike under
the prior law, Amy is eligible for a 20% deduction of $11,000. This makes a big difference. We discussed the changes in the personal exemption
and the standard deduction in earlier segments and you can see their impact here as well. The bottom line for Amy is that she gets a
tax cut compared with the prior law of over $4,200. And more than half of it, $2,420, is attributable
to the new 20% deduction. But, if Amy had earned commission income greater
than the threshold amount of $157,500, a partial deduction may be available. Our last example shows what happens when someone
has income far above the threshold. David Developer owns an S corporation and
he pays himself $80,000 in salary from the business. But the company also earns $370,000 in net
income, which is passed through to David on his own tax return. As you can see, David and his spouse are right
at the phase-out level of $415,000. But because his income does not come from
one of the specified businesses where higher income is not eligible for the deduction,
we can look to the formula to see how much deduction he gets. David’s salary of $80,000 is one factor,
which provides the deduction can be no higher than 50% of the salary paid by the company. This would be $40,000. But the second limiting factor would give
him a higher deduction. This one says that the total of 25% of the
salary paid, which would be $20,000, plus 2.5% of the original cost of depreciable property
owned by the business. In this example, we assume that David has
a building that is worth $1.8 million, not counting the land. 2.5% of this amount is $45,000. Add this to the $20,000 and we get a deduction
of $65,000. This is a big number but it is still smaller
than the full 20% of his net business income, which is $74,000. The bottom line tax saving for David compared
with the prior law is over $38,000, of which more than $21,000 comes from the new deduction
and the rest is from lower tax rates and other changes. These new changes really are revolutionary
for owners of pass-through businesses and the self-employed. My clients are very excited about these changes
but they are also quite confused. It is complicated. This is why we recommend that you consult
with a qualified tax advisor on this new deduction. Every situation is different and we still
do not have the final guidance on how this is going to work in very situation. This concludes this segment of our video series. We hope you have found these to be informative
and valuable. Please feel free to email me with general
questions. NAR is not allowed to give specific tax advice
but we may follow up with clarification in a subsequent video. Thanks for watching.

10 Comments

  • Lorena L. Alvarez

    It was very good to watch all four videos. Thank you. I do have many questions…but will ask one: What happens to the properties one owns which are rentals? I own three single family homes, besides where I live. What happens to the expenses incurred with each one? Taxes, interest paid, repairs?

  • Bryn Kaufman

    Most high income Realtors use a CPA to do their taxes.

    I think if NAR could produce a PDF with bullet points as to what we can go over with our CPA or what things we should look for on our tax returns that would be more helpful.

    In my opinion this video was too long and confusing. NAR has 1 million members and I see under 10,000 views right now so as of now you are appealing to less than 1% of NAR members.

    For any Realtors reading this you might want to think about a Defined Benefits program. If it meets your needs you can put away a lot more money for retirement.

  • Michael Harper

    Let me be sure about your examples: Your example has Amy Agent with NET Commission Income of $67,000 only taking a $11,000 Business Income Deduction instead of $13,400. So you are deducting her standard deduction BEFORE computing her 20% BID. That is not the way I read the law. Would you comment? ($11,000 or $13,400)

  • Tracy Allis

    We don't have time to watch this and it would be great to have just a basic doc with bullets to give us the information. I agree with Bryn

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