Let me tell you what tax planning was like back in 1985. Most businesses operated as C Corporations. Pretty much no one had heard of an S Corporation or knew how they operated. Real estate developers used Limited Partnerships. If you had too much in taxes to pay, you bought a real estate tax shelter. All of the real estate paper losses could be used against your other income. Buy enough shelters and you never pay tax.
One tax act, the 1986 Tax Reform Act changed everything. It drew a line in the sand between self-employed professionals and business owners, at least as it applied to taxes. It moved real estate tax saving devices out of the reach of most taxpayers. Real estate values faltered, then dropped. And in the late 1980’s, there were disastrous real estate failures. Banks closed. The Resolution Trust was set up to stabilize the banking industry to keep it from falling too.
The aftermath of the 1986 Tax Reform Act wasn’t as bad as the current economic crisis….yet.
But there is news out of Congress that could be good, or it could be bad. At the surface, it sounds like a really good idea.
Capitol Hill quietly started a major reform of the federal tax code on June 27th. And two members of the Senate Finance Committee announced plans for tax reform legislation.
The approach, they say, will be similar to what happened with the 1986 Tax Reform Act. They plan to just start over. Nothing is deductible. There are no tax credits. All income is taxable. The trick then is to determine what the individual and corporate tax rates would need to be, considering there are no longer any deductions. Presumably, it will be a lot lower.
But then, this is where it gets tricky. Any senator can then request tax deductions and credits be added back. Rates get adjusted again and voila! We have a new Tax Act.
On the surface, this sounds easy. Nothing is deductible. It’s effectively a flat tax on your income.
If you have real estate, though, you might want to take another look. That means your mortgage interest and property tax for your home are no longer deductible. You might as well rent. And if you’re in a house you’re barely hanging on to since the value slipped, you’ve just lost any tax incentive to hang on.
If you’re a real estate investor, you might have bought for the hope of appreciation, cash flow and tax breaks. Say good bye to the tax breaks. There won’t be capital gains or even presumably like kind exchanges allowed to defer sales.
The concern among many real estate analysts is that as real estate loses the tax breaks, there will be less incentive to buy. And that means dropping values again.
As a CPA and Tax Strategist, I know that there will be loopholes. There always are. My clients will be fine. But I wonder what’s going to happen to the real estate market if these changes come into play. I remember how the 1986 Tax Reform Act lead to real estate market collapses in select markets and that’s when the market was healthy. What will happen to an unstable real estate market, barely getting back on its feet?
The new tax act, whatever it looks like, is expected to be announced this fall. We will be running FREE webinars as soon as we get more information. Please make sure you stay registered for our emails and that we are whitelisted to get through your spam filter. We will announce proposed tax law changes to our community as soon as we know them.