TCJA Caps Deduction Amount for State and Local Taxes (SALT)
This includes property tax and either income tax or sales tax — on a combined basis. The cap could significantly reduce the SALT break for many taxpayers. > Read more...
New Qualified Business Income Deduction for Pass-Throughs
The break is intended to help businesses that won't benefit from the new 21% corporate rate. But not all pass-throughs will qualify. Read more...
Can you still deduct interest on a home equity loan?
The Tax Cuts and Jobs Act caused confusion regarding this deduction. The IRS offers guidance. Read more...
2 Depreciation-Related Breaks Enhanced by the TCJA
Bonus depreciation and Section 179 expensing provide businesses with bigger deduction opportunities. Read more...
New limit! For 2018 through 2025, the TCJA limits your entire deduction for state and local taxes — including property tax and either income tax or sales tax — to $10,000 ($5,000 if you're married filing separately). This will have a significant impact on higher-income taxpayers with large state and local income tax and/or property tax bills.
Individuals generally can take an itemized deduction for either state and local income tax or state and local sales tax. For most taxpayers, deducting state and local income taxes will provide more tax savings. But deducting sales tax can be more valuable to taxpayers residing in states with no or low-income tax or who purchase a major item, such as a car or boat.
Except for major purchases, you don’t have to keep receipts and track all the sales tax you actually paid during the year. Your deduction can be determined using an IRS sales tax calculator that will base the deduction on your income and the sales tax rates in your locale plus the tax you actually pay on major purchases.
For tax years starting in 2018 through 2025, the TCJA creates a new deduction for owners of pass-through business entities, such as sole proprietorships, partnerships, S corporations and limited liability companies (LLCs) that are treated as sole proprietorships, partnerships or S corporations for tax purposes. The deduction generally equals 20% of qualified business income (QBI), subject to limitations that can begin to apply if taxable income exceeds the applicable threshold — $157,500 or, if married filing jointly, $315,000. The limits fully apply when taxable income exceeds $207,500 and $415,000, respectively.
QBI is generally defined as the net amount of qualified items of income, gain, deduction and loss that are effectively connected with the conduct of a U.S. business. QBI doesn’t include certain investment items, reasonable compensation paid to an owner for services rendered to the business, or any guaranteed payments to a partner or LLC member treated as a partner for services rendered to the partnership or LLC.
The QBI deduction isn’t allowed in calculating the owner’s adjusted gross income, but it reduces taxable income. In effect, it’s treated the same as an allowable itemized deduction.
When the income-based limit applies to owners of pass-through entities, the QBI deduction generally can’t exceed the greater of the owner’s share of:
Qualified property is the depreciable tangible property (including real estate) owned by a qualified business as of year-end and used by the business at any point during the tax year to produce qualified business income. Additional rules apply.
Another limitation for tax payers subject to the income-based limit is that the QBI deduction generally isn’t available for income from specified service businesses. Examples include businesses that involve investment-type services and most professional practices (other than engineering and architecture). The W-2 wage limitation and the service business limitation don’t apply if your taxable income is under the applicable threshold. In that case, you should qualify for the full 20% QBI deduction.
Q: Can I continue deducting interest on a home equity loan under the TCJA?
A: Since the passage of the Tax Cuts and Jobs Act (TCJA), there has been confusion over some of the changes to longstanding deductions, including the deduction for interest on home equity debt. In response, the IRS issued a statement clarifying that the interest on home equity loans, home equity lines of credit and second mortgages will, in many cases, remain deductible under the TCJA — regardless of how the debt is labeled.
Under prior tax law, taxpayers who itemized deductions could deduct “qualified residence interest” on up to $1 million of debt secured by a qualified residence and used to acquire, build or improve that residence (referred to as “acquisition debt”), plus interest on home equity debt up to $100,000. (The limits were half those amounts for married taxpayers filing separately.) The home equity debt couldn’t exceed the fair market value (FMV) of the home reduced by the debt used to acquire the home.
But the $100,000 limit didn’t apply to the extent the home equity debt qualified as acquisition debt. For example, if the home equity debt was used to improve the home securing that debt, the $100,000 limit didn’t apply.
For tax purposes, a qualified residence is the taxpayer’s principal residence and a second residence, which can be a house, condominium, cooperative, mobile home, house trailer or boat (if it has kitchen and bathroom facilities). The principal residence is where the taxpayer resides most of the time; the second residence is any other residence the taxpayer owns and treats as a second home.
Taxpayers aren’t required to use the second home during the year to claim the deduction. If the second home is rented to others, though, the taxpayer also must use it as a home during the year for the greater of 14 days or 10% of the number of days it’s rented.
If a taxpayer had a principal residence and a second residence, the $1 million debt limit applied on an aggregate basis; it wasn’t $1 million per home. Home equity debt that qualified as acquisition debt was also generally subject to the aggregate $1 million limit.
Interest on home equity debt up to the $100,000 limit was deductible regardless of how the proceeds were used. A taxpayer could, for example, use the proceeds to pay for medical bills, tuition, vacations, vehicles and other personal expenses and still claim the itemized interest deduction.
In addition, courts had ruled that the $100,000 limit could also apply to home equity debt that qualified as acquisition debt, effectively meaning a taxpayer could deduct interest on acquisition debt up to $1.1 million in certain circumstances.
The TCJA Rules
The TCJA reduces the limit on the amount of the mortgage interest deduction through 2025. Beginning in 2018, for mortgage debt incurred after December 15, 2017, a taxpayer generally can deduct interest only on mortgage debt of up to $750,000, or $375,000 for separate filers. (For debt incurred on or before that date, the debt limit remains at $1 million or $500,000, respectively.)
The congressional conference report on the law stated that it also suspends the deduction for interest on home equity debt. And the actual bill includes the section caption “DISALLOWANCE OF HOME EQUITY INDEBTEDNESS INTEREST.” As a result, many people believed the TCJA eliminated the home equity debt interest deduction.
On February 21, 2018, the IRS issued a release (IR 2018-32) explaining that the law suspends the deduction only for interest on home equity loans and lines of credit that aren’t used to buy, build or substantially improve the taxpayer’s home that secures the debt. In other words, the interest isn’t deductible if the home equity debt is used for certain personal expenses, but it is still deductible if it’s used in a way that allows it to qualify as acquisition debt, such as if the proceeds go toward a new roof on the home that secures the debt.
The IRS further stated that the $750,000 limit applies to the combined amount of mortgage and home equity acquisition debt.
Some examples from the IRS help show how the TCJA rules work:
Example 1: A taxpayer took out a $500,000 mortgage to buy a principal residence with an FMV of $800,000 in January 2018. The loan is secured by the residence. In February, he took out a $250,000 home equity loan to pay for an addition to the home. Both loans are secured by the principal residence, and the total doesn’t exceed the value of the home.
The taxpayer can deduct all of the interest on both loans because the total loan amount doesn’t exceed $750,000. If he used the home equity loan proceeds to pay off student loans and credit card bills, though, the interest on that loan wouldn’t be deductible.
Example 2: The taxpayer from the previous example took out the same mortgage in January. In February, he also took out a $250,000 loan to buy a vacation home, securing the loan with that home. Because the total amount of both mortgages doesn’t exceed $750,000, he can deduct all of the interest paid on both mortgages. But, if he took out a $250,000 home equity loan on the principal home to buy the second home, the interest on the home equity loan wouldn’t be deductible.
Example 3: In January 2018, a taxpayer took out a $500,000 mortgage to buy a principal home, secured by the home. In February, she took out a $500,000 loan to buy a vacation home, securing the loan with that home. Because the total amount of both mortgages exceeds $750,000, she can deduct only a portion of the total interest she pays on them.
The new IRS announcement highlights the fact that the nuances of the TCJA will take some time to shake out completely. Contact us to learn about the latest developments.
For assets with a useful life of more than one year, you generally must depreciate the cost over a period of years. In most cases the Modified Accelerated Cost Recovery System (MACRS) will be preferable to the straight-line method because you’ll get a larger deduction in the early years of an asset’s life.
But if you make more than 40% of the year’s asset purchases in the last quarter, you could be subject to the typically less favorable mid-quarter convention. When it comes to repairs and maintenance of tangible property, however, different rules may apply. Careful planning during the year can help you maximize depreciation deductions in the year of purchase.
Other depreciation-related breaks and strategies also are available, and in many cases enhanced by the TCJA:
Enhancement! Bonus depreciation. This additional first-year depreciation is available for qualified assets, which include new tangible property with a recovery period of 20 years or less (such as office furniture and equipment), off-the-shelf computer software, water utility property and, possibly, qualified improvement property.
Under the TCJA, for assets placed in service after Sept. 27, 2017, though Dec. 31, 2026, the definition has been expanded to include used property and qualified film, television and live theatrical productions. For qualified assets placed in service after Sept. 27, 2017, but before Jan. 1, 2023, bonus depreciation is 100% (up from 50%).
In later years, bonus depreciation is scheduled to be reduced as follows:
For certain property with longer production periods, these reductions are delayed by one year. For example, 80% bonus depreciation will apply to long-production-period property placed in service in 2024.
Warning: Under the TCJA, in some cases, a business may not be eligible for bonus depreciation starting in 2018. Examples include real estate businesses that elect to deduct 100% of their business interest and dealerships with floor-plan financing, if they have average annual gross receipts of more than $25 million for the three previous tax years.
Enhancement! Section 179 expensing election. This allows you to deduct (rather than depreciate over a number of years) the cost of purchasing eligible new or used assets, such as equipment, furniture, off-the-shelf computer software, and qualified improvement property. Under the TCJA, for qualifying property placed in service in tax years beginning in 2018, the expensing limit increases to $1 million. The break begins to phase out dollar for dollar when asset acquisitions for the year exceed $2.5 million (compared to $2.03 million for 2017). For later tax years, these amounts will be indexed for inflation. You can claim the election only to offset net income, not to reduce it below zero to create a net operating loss.
Tangible property repair safe harbors. A business that has made repairs to tangible property, such as buildings, machinery, equipment and vehicles, can expense those costs and take an immediate deduction. But costs incurred to acquire, produce or improve tangible property must be depreciated. Distinguishing between repairs and improvements can be difficult. Fortunately, some IRS safe harbors can help: 1) the routine maintenance safe harbor, 2) the small business safe harbor, or 3) the de minimis safe harbor. The rules are complex, so contact your tax advisor for details.
Cost segregation study. If you’ve recently purchased or built a building or are remodeling existing space, consider a cost segregation study. It identifies property components and related costs that can be depreciated much faster and dramatically increase your current deductions. Typical assets that qualify include decorative fixtures, security equipment, parking lots, landscaping and architectural fees allocated to qualifying property. See the Case Study "Cost segregation study can accelerate depreciation."
The benefit of a cost segregation study may be limited in certain circumstances — for example, if the business is located in a state that doesn’t follow federal depreciation rules.