CAPITAL GAINS TAXES AFTER THE NEW TAX LAW IN EFFECT

We have had many calls from clients and our fellow Brokers out in real estate land asking about the effects of the new tax laws coming into effect this next year practically related to capital gains and real estate investment. There has been so many articles and commentators out there talking today so that a few pieces of information on how the tax law changes can affect real estate investors I think can provide some real value for our readers.

TAX DEFERRED EXCHANGES ARE STILL ALIVE AND WELL, THANK YOU, AFTER THE NEW TAX CHANGES

You may not know this, but Section 1031 tax deferred exchanges were potentially on the chopping block as the Congress looked at tax law changes. While in existence since 1921, many politicians looked at tax exchanges as enhancing the wealth of real estate investors and looked to take that benefit away. At the end of the day, Section 1031 exchanges are with us, but with a major change.

PERSONAL PROPERTY TAX DEFERRED EXCHANGES WERE ELIMINATED FROM TAX DEFERRAL

There are TWO (2) types of tax deferred exchanges: One for personal investment property; another for real estate investment property. Our readers are certainly aware of real estate exchanges, but you may not

be aware of personal property exchanges. THEY ARE HUGE!!! They involve fleet leases of vehicles, aircraft, oil and gas mine leases and the like. They have nothing to do with real estate.

In short, these types of personal property tax deferred exchanges have been eliminated by the law. They are gone. So many have called our office believing that all exchanges are gone that we attempt to make it clear here. REAL ESTATE tax deferred exchanges are alive and well after the new law changes. We continue as we have before. Again, REAL ESTATE tax deferred exchanges are alive and well after the tax law change.

CAPITAL GAINS TAX MATTERS REALLY REMAIN THE SAME AFTER THE NEW LAW CHANGE

Again, nothing has changed in the basic capital gains tax calculations because of the tax law change.

Let us begin with long-term capital gains. Long-term capital gains are still defined as gains made on assets that you hold for over a year, while short-term capital gains come from assets you hold for a year or less. Long-term gains are taxed at rates of 0%, 15%, or 20%, depending on your tax bracket; while short-term gains are taxed as ordinary income.

3.8% OBAMA-CARE SURCHARGE STILL APPLIES!!!!... WAS NOT REPEALED!!!!!!

Also, for both types of capital gains, it's worth noting that the 3.8% net investment income tax that applies to certain high earners will stay in place, with the exact same income thresholds. This is part of the Affordable Care Act, which Congress has not successfully repealed or replaced. So this tax remains.

The long-term capital gains tax rates of 0%, 15%, and 20% still apply. However, the way they are applied has changed slightly. Under previous tax law, the 0% rate was applied to the two lowest tax brackets, the 15% rate was applied to the next four, and the 20% rate was applied to the top bracket.

Under the new tax law, the three (3) capital gains income thresholds don't match up perfectly with the new tax brackets. Instead, they are applied to maximum taxable income levels, as follows:

Long-Term Capital Gains Rate	Single Taxpayers	Married Filing Jointly	Head of Household	Married Filing Separately
0%	Up to $38,600	Up to $77,200	Up to $51,700	Up to $38,600
15%	$38,600-$425,800	$77,200-$479,000	$51,700-$452,400	$38,600-$239,500
20%	Over $425,800	Over $479,000	Over $452,400	Over $239,500

Data source: Tax Cuts and Jobs Act.

If you look at the tax bracket charts later in this article, you might notice that these thresholds are based on the previous tax brackets. In other words, your long-term capital gains taxes in 2018 will be virtually the same as they would have been if no tax reform bill had passed.

DON’T FORGET THAT SHORT TERM CAPITAL GAINS ARE STILL TAXED AS ORDINARY INCOME!!

On the short-term capital gains side, short-term gains are still considered ordinary income, so the effect is more obvious. If your marginal tax rate has changed, your short-term capital gains tax will change as well.

For comparison, here are the newly passed 2018 tax brackets:

Marginal Tax Rate	Single	Married Filing Jointly	Head of Household	Married Filing Separately
10%	$0-$9,525	$0-$19,050	$0-$13,600	$0-$9,525
12%	$9,525-$38,700	$19,050-$77,400	$13,600-$51,800	$9,525-$38,700
22%	$38,700-$82,500	$77,400-$165,000	$51,800-$82,500	$38,700-$82,500
24%	$82,500-$157,500	$165,000-$315,000	$82,500-$157,500	$82,500-$157,500
32%	$157,500-$200,000	$315,000-$400,000	$157,500-$200,000	$157,500-$200,000
35%	$200,000-$500,000	$400,000-$600,000	$200,000-$500,000	$200,000-$300,000
37%	Over $500,000	Over $600,000	Over $500,000	Over $600,000

Data source: Joint Explanatory Statement of the Committee of Conference.

And, here are the previous 2018 tax brackets (which were announced by the IRS but will not go into effect):

Marginal Tax Rate	Single	Married Filing Jointly	Head of Household	Married Filing Separately
10%	$0-$9,525	$0-$19,050	$0-$13,600	$0-$9,525
15%	$9,525-$38,700	$19,050-$77,400	$13,600-$51,850	$9,525-$38,700
25%	$38,700-$93,700	$77,400-$156,150	$51,850-$133,850	$38,700-$78,075
28%	$93,700-$195,450	$156,150-$237,950	$133,850-$216,700	$78,075-$118,975
33%	$195,450-$424,950	$237,950-$424,950	$216,700-$424,950	$118,975-$212,475
35%	$424,950-$426,700	$424,950-$480,050	$424,950-$453,350	$212,475-$240,025
39.6%	Over $426,700	Over $480,050	Over $453,350	Over $240,025

Data source: IRS.

APPLYING SHORT TERM ANALYSIS

For example, let's say you're single and have taxable income of $50,000 per year. If you buy a piece of real estate and sell it a couple of months later for a $2,000 profit, you would have to pay tax at a rate of 25% under the previous tax brackets, while the new tax brackets give you a lower 22% marginal tax rate. This would result in tax savings on your short-term sale of $60.

BOTTOM LINE……………. A LOT OF THE SAME…… EXCHANGES ALIVE AND WELL

While nothing significant changed in the capital gains tax structure, or in the long-term capital gains tax rates, your 2018 short-term capital gains tax could change because of the new tax brackets. Generally, lower marginal tax rates and different income thresholds for most tax brackets combine to produce a potential short-term capital gains tax cut for many investors.

In a nutshell:

*********Capital gains tax is still with us

*********Brackets can have a slight impact

*********3.8% surcharge NOT repealed

*********Tax deferred exchanges for real estate alive and well

*********Can defer capital gains tax (both short term and long term)

*********Exchange can eliminate 3.8% surcharge obligation

*********Personal property exchanges eliminated by new law.

We have many real estate sales professionals out there that respond to our “Legal-Line” with a long, long recital of facts and seeking an attorney answer to the fact pattern believing that there is a simple answer. Frankly, some of your colleagues get upset when we can’t give a black and white answer to a complex group of facts and circumstances.

Washington State law is derived from many sources including the Revised Code of Washington (“RCW”) as enacted by the Legislature and interpreted by the Washington State Court of Appeals and Washington State Supreme Court.

Although accessible, the RCW is extensive and not always consistent and determining your legal rights is not always as simple as looking to “the letter of the law”. In short, in the law and in “Legal-Line” there is many times no simple answer. Here’s an example of a case here in Washington State where the court had to reconcile a variety of conflicting laws to decide a case. Each individual law was clear.

Last year, the Washington State Court of Appeals resolved a conflict between Washington’s Homestead Act (CH. 6.13, RCW), Redemption Act (CH. 6.23, RCW ) and Condominium Act (CH. 64.34 RCW).

In Viewcrest Condominium Association v. Robertson, 197 Wn. App. 334, 387 P.3d 1147 (2016), the Washington State Court of Appeals Division One (up in Seattle) held that a condominium owner had the right to possession of a foreclosed condominium during the statutory redemption period with no obligation to pay rent despite a statute to the contrary in the Condominium Act. See where we are going here? The law is many times clear, but when viewed in totality with other statutes, the analysis can get muddy.

*****In Viewcrest, a condominium owner became delinquent in their assessment dues.

*****The Condominium Association recorded an assessment lien commenced a judicial foreclosure against the condominium owner.

*****At the foreclosure action, the Association was the winning bidder.

*****The Association offered the condominium owner with the option to remain in the unit during the post-foreclosure redemption period for fair market rent. The condominium owner did not respond, and the Association preceded to evict the condominium owner.

RESULT FROM THE TRIAL COURT

At the eviction proceedings, the owner was evicted. The condominium owner appealed.

RESULT FROM THE COURT OF APPEALS

The Court of Appeals reversed the trial court proceedings and overturned the eviction based on the following statutory considerations:

The Redemption Act grants a homeowner the right to live in the home during the redemption period that follows a forced sale: “In case of any homestead as defined in chapter 6.13 RCW and occupied for that purpose at the time of sale, the judgment debtor shall have the right to retain possession thereof during the period of redemption without accounting for issues or for value of occupation.” RCW 6.23.110(4).

The Homestead Act generally defines “Homestead” as “real or personal property that the owner uses as a residence.” RCW 6.13.010. Washington citizens are entitled to certain homestead protections which are derived from the Washington State Constitution.

However, the Condominium Act states that liens authorized by that chapter (including assessment liens) are not subject to homestead protections. RCW 64.34.364(2).

The Court of Appeals did not address any constitutional concerns in its decision, but rather interpreted the three (3) statutory schemes together to recognize a homestead property owner to reside at that property without having to pay rent during the post-foreclosure redemption period as provided in the Redemption Act.

PRACTICE POINTER: The practice pointer here is that the law is not always certain even when it may appear clear from the plain language of the statute. We have encountered clients who are at risk of being taken advantage of in post-sale redemption situations. Best practice is to have a client consult with an attorney to resolve legal issue rather than move forward with uncertainty.

PRACTICE POINTER: The availability of all the laws in Washington on the Internet has created many parties’ having the belief that the law is clear in a certain matter and it is only after we dig more deeply in the matter that we find that additional facts can change the specific statute that applies and can affect its applicability. Very seldom is anything a slam dunk. Please resist the urge to advise any of your customers and clients that they have strong legal positions until they have consulted with competent counsel.