Can real estate brokers cash in on this tax deduction? No one knows
Law isn't yet clear on who is excluded on pass-through businesses
The new GOP tax law is widely considered a win for high-earners, but it’s not clear if real estate brokers and their firms will also benefit from a hefty deduction granted to pass-through businesses.
The so-called pass-through deduction has been billed as a boon to independent contractors, including Uber drivers and freelancers, but its application to real estate agents remains murky. If a broker makes less than $157,500 a year (or $315,000 if filing as a married couple), he or she will automatically qualify for the 20 percent deduction. Of course, brokers selling luxury real estate in cities like New York City, Miami or Los Angeles, likely make significantly more than that, so additional restrictions apply.
“For brokers, it’s a little bit of a mixed bag,” said Aaron Lerner, a senior tax manager at Eisner Amper. “You have a situation where the income limits, before you even look at the other limits, is sort of low.”
Above that income threshold, two main hurdles stand in the way of brokers securing the deduction, Lerner said. The first is the exemption of “specified service businesses,” which the law defines as those that provide “services in the fields of health, law, accounting, actuarial sciences, performing arts, consulting, athletics, financial services, brokerage services or any trade or business where the principal asset of such trade or business is the reputation or skill of one or more of its employees or owners.” The definition of “brokerage” here is nebulous, said Michael Greenwald, partner and leader of the corporate and business tax practice at Friedman LLP. It’s unclear if the law is referring to just financial brokers or “anyone who brokers anything,” he said.
Brokers also often market themselves based on their knowledge and experience in a given neighborhood or with a particular asset type. Thomas Gallagher, a partner at Philadelphia-based law firm Cozen O’Connor, notes in a January article released by his firm that advertisements for high-producing teams — think the Eklund-Gomes Team or Alexa Lambert Team — basically “scream reputation and personal skill.” He said some brokers may be advised to change their marketing strategies to increase their chances at qualifying for the deduction.
The Internal Revenue Service is expected to issue additional guidelines for the tax law in June. If it’s ultimately determined that real estate brokers provide a “specified service,” the deduction won’t be available to any broker who makes $207,500 or more ($415,000 for joint filers). Greenwald said brokers should probably wait to see what the IRS releases before shifting advertising strategies.
“Until we get more guidance, I would caution people not to do anything,” he said. “I would hate to think someone’s changing their behavior or significantly altering their business based on speculation.”
He also noted that the deduction, which becomes effective in 2018, expires in 2025 so businesses shouldn’t get too dependent on the extra cash.
The second hurdle is arguably even greater. To determine the limitation on deductions for individuals making more than $157,500, a formula primarily involving W-2 wages (limited to the greater of 50 percent of these wage and the sum of 25 percent of W-2 wages and 2.5 percent of the unadjusted basis of qualified property) is used. For most real estate brokers, who file taxes as independent contractors and file a 1099 form rather than a W-2, that limitation formula likely means that they won’t get a deduction.
Outside the deductible, the new tax law is expected to impact homes sales. According to the Wall Street Journal, this spring could be one of the slowest selling seasons in recent years, due in part to the law’s cap on mortgage-interest deductions and on state and local tax deductions. Still, Michael Graves, a broker at Douglas Elliman, noted that the tax law has been good for business, given its perks for high net-worth individuals.
“The really important thing for those of us who work in the high-end of the market, is that our clients are being positively affected by this,” he said. “If you are a volume broker, doing deals south of $3 million, you are probably taking a hit.”
Steven Klein, a partner at Miami-based Gerson Preston, said that he’s working with various real estate professionals to determine the best way to structure S-Corporations and other entities to maximize their deductions.
“There’s a lot to do with real estate clients,” he said. “The benefits can be great, but the pitfalls are there if you don’t structure things properly.”