Landlord Tenant Q&A: DARLENE HIGA (RA), MPM, RMP
DARLENE HIGA (RA), MPM, RMP
Property Profi les, Inc.
Past President, Oahu Chapter
National Association of Residential Property Managers
Q. I have been hearing about Congress working on tax reform and the possibility of losing some of the tax deductions that go along with owning real estate. How will this affect my rental properties and real estate in general if this goes through?
A. The House of Representatives “Blueprint” is what you’ve been hearing about. There are several proposals being discussed and nothing is set in stone as of today, but the House Republicans are working quickly to get something on the table by midyear. What we’ve been hearing is that “tax reform” will basically simplify the tax code. In fact, pretty much get rid of everything! Your tax return will be filed on a “postcard” whereby you enter your income, take a higher standard deduction, then pay your taxes…simple! Most exemptions, deductions, credits, etc. other than the standard deduction and maybe, a charitable deduction, and hopefully a mortgage interest deduction will be eliminated. How will this affect your real estate investments? Well, so far, the only investment real estate expenses put into question are depreciation and the interest deduction. Real estate taxes, maintenance fees, cleaning, repairs, and all the usual expenses that a landlord has would continue to be deductible on Schedule E under the Blueprint. However, because the Blueprint would speed up depreciation from 27.5 years (in the case of residential rental property) to one year, the proposal could also deny the deductibility of the interest expense. There is a lot of discussion going on regarding the immediate expensing concept and the deniability of interest expense so we do not know the consequences as we have not seen the details. Both pose huge questions for commercial and investment real estate, thus the impact could be major. The immediate expensing could be a big benefit, if it works as it has been outlined. But denying the interest expense would be a big negative. One big question is whether there would be a net benefit or a net detriment, and we just do not yet know. When concrete proposals appear, we’ll be able to assess the net effect which could greatly affect real estate investors and it is something that all investors should be watching very carefully.
Another tax law that is subject to elimination is the use of a 1031 exchange. Current tax law allows you to defer the gain on an investment property if you sell and buy a replacement property equal to or more in value and complete the exchange in set time frames. If this is no longer possible, one could have a large tax burden to pay each time one sells their property. There is talk about accelerating depreciation into the first year which may or may not offset the tax burden on the sale side, but again things are fluid and are in the discussion phase in Congress.
Regarding your residence, the mortgage interest deduction and real estate property tax deduction may be eliminated. This would be a huge loss for Hawaii residents because our prices are so high. It’s not uncommon for buyers to take out a large mortgage of at least $300,000 to over $500,000. With the median price of a single family home reaching $800,000, a buyer with 20% down payment would have a mortgage of $640,000. This would equate to a mortgage interest deduction of around $28,000 for the first year, or approximately $7,000 in tax savings assuming a 25% tax rate. If Congress gets rid of the mortgage interest deduction, you will bear the cost of the full mortgage payment. Other states may not be impacted as we would since the median price of a home across the country is under $250,000, so there may be less push back from consumers in lower cost states.
The National Association of Realtors are gearing up to fight and preserve the benefits of home ownership and the incentives to owning real estate. They are approaching it from an incentive standpoint and not looking at it as a tax savings issue. Everyone knows that a neighborhood made up of homeowners has tangible benefits such as more stable families, less crime, higher education scores, and a more vibrant economy. Keeping incentives to own and buy real estate is paramount to our way of life in the United States of America. It is the “American Dream” and defines us as Americans, not to mention that is also drives 20% of our GDP. So as tax reform proposals hit the floor of the House and the Senate, it would behoove all residents of Hawaii to seriously look at the impact it will have on our lives as well as the lives of future generations in our state.