As we approach the end of another stellar year for commercial real estate, we are seeing the usual flurry of transactions in process with buyers and sellers trying to consummate sales before the end of the year. While there are advantages to a year end closing, the Tax Cut and Jobs Act of 2017 gives some sellers a large tax advantage to wait until just after the beginning of the new year to close.
One of the provisions of the legislation allows owners of pass-through business entities to deduct up to 20% of the income earned by the business. Since many commercial real estate investors have their businesses set up this way, they are able to take advantage of the 20% deduction in net income if they meet the requirements. For single investors with income under the threshold of $157,500 and married taxpayers filing jointly under $315,000 they will meet the requirement and be able to take advantage of the deduction. However, the 20% gets phased out as single tax payers reach $207,500 and married taxpayers reach $415,000. If you are in a specified service trade or business (SSTB) such as an accountant, attorney or physician, you will not be able to benefit from the deduction if your income exceeds these thresholds.
However, if your primary business is real estate investment, or another non-SSTB, you may still have an opportunity to take a deduction. The deduction can be up to 20% of the Qualified Business Income provided that it is not greater than the larger of either:
- 50% of wages paid or
- 25% of wages plus 2.5% of the unadjusted cost basis of the depreciable property at the end of the tax year
For real estate investors with no employees, this means they can only deduct 2.5% of the cost basis of the building (up to the 20% of income). If they sell the property before the end of the year, the cost basis at the end of the year will be zero and they will not get any deduction. If they wait until the first week of January to sell, they will still be able to take the cost-basis deduction.
On the flip side, if an investor has fully depreciated the property (after 39 years for commercial buildings and 27.5 years for residential property) the cost basis would be zero at the end of the 39th or 27.5th year and the investor would not be able to take the deduction, so selling before the property is fully depreciated would be beneficial. If you think you fall into this category, make sure to talk to your accountant to see if you would benefit from closing on your property this year or waiting to close on the sale until early in 2019.
-Dan Stiebel, CCIM