Individual mandate removed
Taxpayers who don’t carry health insurance will no longer pay a penalty for remaining uninsured — this was called the individual mandate to induce everyone to be insured no matter the level of personal health.
The impact of repealing the individual mandate will be twofold:
- an immediate tax break for those taxpayers who did not have health insurance as they will no longer pay a tax penalty; and
- higher insurance rates for everyone who has health insurance.
The reason? The individual mandate was an effort to induce more healthy people to sign up for health insurance. These additional premiums helped insurers keep their costs down, and if not, the government collected a tax penalty to cover the increased cost of government payments to health insurers.
But now that healthy people don’t face a penalty for enrolling in basic health insurance plans, insurers are left with a higher share of sick people on insurance since healthy individuals will opt out. When more of the insured are using their health plans because of illness or other ailments, insurance become more costly.
However, the 3.8% tax on net investment income and profits added by the Affordable Care Act remains in place under the new rules. The Affordable Care Act added a 3.8% tax on net investment income and profits (classified as unearned income) when modified adjustable gross income (AGI) exceeds a threshold of $250,000 for joint filers (or $200,000 for single filers). For real estate investors, this includes income and profit from:
- the operations and sale of rental property; and
- interest income on savings and trust deed notes, earnings on land held for profit and rents received on triple net leased property.
Other miscellaneous changes impacting real estate
Beginning in 2018 and through 2026, taxpayers may choose to defer the gain from the sale or exchange of property when the money is reinvested in a qualified opportunity zone within 180 days of the sale. [26 United States Code §1400Z-2(a)]
This rule rewards investors who put money into low-income areas which don’t often see investment, designated opportunity zones by California’s state government. Much like a §1031 exchange, the profit does not “disappear” in the eyes of the IRS. Rather, it is deferred until the investor sells the property or until December 31, 2026, whichever comes sooner. [26 USC §1400Z-2(b)]
Another change ushered in during the 2018 tax year is a decrease to the
corporate tax rate
for C corporations (a corporation taxed separately from its owners as distinguished from S corporations, partnerships and LLCs). Many brokerage firms are structured as C corporations and thus the decrease applies to them. Previously, the corporate tax rate for C corporations was graduated, capping out at 35%. Now, the corporate tax rate is a flat 21%. [26 USC §11(b)]
This tax reduction not only hugely decreases the amount of money C corporations owe the IRS, but it effectively increases the value of C corporation ownership – the investors holding the company stock.
The 2018 changes also include a cap to net operating loss (NOL) taken by a business. Previously, NOLs were able to offset up to the full amount of taxable income carried backward up to two years and forward by 20 years. Now, NOLs may only be carried forward, not backward, and the threshold is limited to 80% of the taxable income each year. [26 USC §172(a); (b)]
Tax changes impact home values
Before the 2018 tax changes, taxpayers who itemized their deductions were able to deduct the full amount paid in SALT taxes each year, essentially avoided the compounding of paying federal taxes on their state tax payments.
Now, SALT deductions are capped at $10,000 — the same for single and married taxpayers. For many Californians (and other taxpayers located in high-tax and high-income states, like New York and New Jersey), their SALT taxes well exceed the new cap. This translates to being taxed at the federal level on additional taxable income that under previous rules was deductible in full.
When it comes to housing, taxpayers with the most expensive homes — and thus higher property tax payments — are also paying more federal taxes under the new SALT limit. Higher tax payments by wealthier individuals will have a domino effect on home sales in California, causing reduced home values in high-tier residential properties, according to a study by the
Cleveland Federal Reserve Bank
The CFRB study finds the average home value change across the U.S. will be -5.7%. In other words, home values will be 5.7% lower than they otherwise would have been under the old rules which allowed taxpayers to deduct their full SALT payments.
However, due to the state’s higher home values, this reduction will be much more significant for California’s homeowners. Here, the average price difference due to the SALT cap will be:
- -8.7% in Vallejo;
- -8.6% in Oakland;
- -8.6% in Riverside;
- -8.5% in San Diego;
- -8.4% in Los Angeles;
- -8.4% in Bakersfield;
- -7.7% in San Jose;
- -7.1% in Stockton;
- -7.0% in Fresno; and
- -5.9% in San Francisco.
This negative price change will be on top of any other market factors – recoveries, recessions, immigration, trade – which push and pull on prices. For example, 2018’s rising interest rates and falling sales volume have already begun to pull back on home prices in 2019.