The recent tax legislation brought some welcome relief in the area of state and local tax deductions, and I want to walk you through what this means for real estate investors.
Understanding the SALT Cap Change
With the Inflation Reduction Act, the SALT cap was set at $10,000. If you were itemizing your deductions on your individual tax return, you were capped at $10,000 of state and local taxes you could deduct. This included real estate taxes, personal property taxes, withholdings, and any state taxes you were paying.
The new legislation increases this cap significantly - from $10,000 to $40,000. Additionally, this $40,000 is going to increase by 1% each year through tax year 2029.
Important Limitations to Know
There are a few key things to be aware of:
Time Limitation: This is only a five-year tax law for the salt cap increase, so this benefit has an expiration date.
Income Phase-Out: There is a phase-out if your adjusted gross income is above $500,000. The deduction will phase down and you may not get that entire $40,000 salt deduction if your AGI exceeds this threshold. However, it will not go below the $10,000 minimum, so you'll still get at least that much if you itemize.
The PTET Election Continues
The Pass-Through Entity Tax (PTET) election is still alive and well. This workaround allowed taxpayers to pay their state taxes at the entity level, creating a federal deduction for those state tax payments, and then creating a credit for the state. There's an add-back on the state side and a credit for the state.
In theory, if you made this election and all of your income was from your pass-through entity, you would not have a personal tax liability at the state level on your personal tax return.
I imagine most taxpayers will still take advantage of this if they have a pass-through entity - so we're talking about a partnership for most of our real estate investors where your real estate is held in a partnership, in a pass-through entity, and all of that income and deductions are flowing through to you personally as the owners.
Who Benefits Most from the Increased SALT Cap
This increased SALT cap could be particularly good for some of our real estate investors that maybe have a smaller portfolio. These are investors who are recording their activity on either Schedule C or Schedule E of their personal income tax return and aren't able to take advantage of the PTET election. Those folks may be able to take more advantage of this increased salt cap to $40,000 instead of the $10,000 cap that existed before.
Looking Back at Our Predictions
I have to admit, we were off in our timing predictions. In our last episode when I spoke with Rich Headley, our state and local tax partner at Brown Edwards, we both didn't think legislation was going to happen before that episode came out. Well, sure enough, the tax bill was signed into law on July 4th, and our episode dropped on July 5th.
While we didn't have any definitive language in that podcast, our expectation was that this bill was going to get signed closer to August or September. But Congress moved pretty swiftly and quickly and got this done by July 4th.
The Bottom Line
All in all, this was good news. We expected the salt cap to increase in some capacity, and this significant jump from $10,000 to $40,000 provides meaningful tax relief for many real estate investors, especially those who haven't been able to take full advantage of the PTET election.
As always, the interaction between these various tax strategies can be complex, so it's important to work with your tax advisor to determine the best approach for your specific situation.