On December 22, 2017, President Donald Trump signed the Tax Cuts and Jobs Act (Act) into law. The Act, which took effect on January 1, 2018, includes several changes to the Internal Revenue Code (IRC) affecting both commercial and residential real estate owners. Most notably, the Act:

The full text of the Act is available on Congress's website.

Under the Act, taxpayers can deduct up to 20% of qualified business income (QBI) earned from pass-through entities. Unlike corporations, pass-through entities are not taxed at the entity level. Rather, the entity's owners are taxed individually on income earned from the entity. The pass-through deduction is particularly important for commercial real estate owners, which are typically organized as pass-through entities such as partnerships, limited liability companies (LLCs), and REITs.

The scope of the pass-through deduction is limited to QBI, which the Act defines as any income, gain, deduction, or loss with respect to a trade or business that is effectively connected with the conduct of a United States trade or business (within the meaning of Section 864(c) of the IRC).

The Act provides several exceptions to QBI, however, including:

The taxpayer's income is the first factor to consider in calculating the pass-through deduction. Under the new tax plan, taxpayers with up to $315,000 (for joint filers) or $157,500 (for single filers) of taxable income are entitled to the full 20% deduction.

Taxpayers with over $315,000 (for joint filers) or $157,500 (for single filers) of taxable income may deduct the greater of:

For example, an LLC that owns $100,000 in equipment and pays $50,000 in W-2 wages would be entitled to a $25,000 deduction because 50% of its W-2 wages ($25,000) is greater than the sum of 25% of its W-2 wages ($12,500) and 2.5% of the unadjusted basis of all depreciable property immediately after acquisition ($2,500).

The total deduction allowed under this formula is split pro rata between the owners of the pass-through entity. If ownership of the LLC in the above example was split 50/50 between two members, each member would be entitled to a $12,500 deduction.

For more information on taxation of pass-through entities, see Practice Notes:

For more general information on pass-through entities, see Practice Notes, Real Estate Investment Vehicles: Overview and Joint Ventures: Overview.

Additionally, the Act allows taxpayers to deduct 20% of qualified REIT dividends. A qualified REIT dividend is any REIT dividend that is not:

For more information on REITs, see Practice Notes, REITs: Overview and Using REITs in Commercial Real Estate Investments.

The Act reduces the maximum corporate tax from 35% to 21%. The reduced corporate tax rate may benefit REITs by minimizing taxes on investment income from taxable REIT subsidiaries. (See IRC § 856(l).)

The Act caps the deduction for interest expenses at 30% of adjusted taxable income. Adjusted taxable income is computed without regard to depreciation, amortization, and depletion for the taxable years beginning before January 1, 2022. Adjusted taxable income will take depreciation, amortization, and depletion into account after that date.

The Act allows real property trades or businesses to opt out of this limit (see IRC § 163(j)(7)(A)(ii)). Real estate trades or businesses that opt out are required to use a longer depreciation recovery period. Generally, the depreciation recovery period is:

For real estate trades or businesses that opt out of the limitation, however, the recovery period is:

The Act limits the use of like-kind exchanges to exchanges of real property. The like-kind exchange rule, which is often used to defer capital gains tax, provides that no gain or loss is recognized on the exchange of real property held for productive use in a trade or business if both of the following conditions are satisfied:

For more information on 1031 like-kind exchanges, see:

The Act allows taxpayers to expense the cost of qualified real property used in the conduct of a trade or business that is placed in service during the taxable year. Qualified real property includes:

For property placed in service before December 31, 2017, the maximum amount a taxpayer can expense is $500,000. A phase-out provision reduces the $500,000 limit by the amount that the cost of the property placed in service during the tax year exceeds $2 million. For property placed in service after December 31, 2017, the expense limitation is $1 million and the phase-out amount is $2.5 million.

The mortgage interest deduction allows taxpayers to deduct the amount of interest paid on a mortgage secured by their principal residence or second home (see 26 U.S.C. § 163(h)(3)).

The Act reduces the cap on mortgage interest deductions from $1 million to $750,000 for homes purchased on or after December 15, 2017. The $1 million cap still applies to homes purchased before December 15, 2017.

More homeowners may benefit from taking the standard deduction instead of itemizing their deductions and taking the mortgage interest deduction.

The Act caps the deduction for state and local income and property taxes at $10,000. As a result, homeowners who regularly pay more than $10,000 in property taxes will see their federal taxes increase.

Before January 1, 2018, the IRC allowed an unlimited deduction for property taxes. Across the country, homeowners attempted to take advantage of the unlimited deduction by pre-paying their 2018 property taxes before the Act took effect. On December 27, 2017, however, the Internal Revenue Service (IRS) issued an advisory letter explaining that the unlimited deduction only applies if the taxpayer makes the payment in 2017 and the property taxes are assessed prior to 2018. When a property tax is assessed, the advisory letter added, depends on state or local law.

The full text of the IRS advisory letter is available on its website.