Planning for Tax Reform: Steps to Take Before the End of 2017
Congress appears poised to pass the most significant tax reform legislation since 1986. It is expected that the Tax Cuts and Jobs Act will be passed and signed into law before the end of 2017, and that most provisions will be effective for the 2018 tax year. This gives taxpayers a very narrow window of opportunity to take advantage of current tax rules before they expire or are scaled back. The final details of the legislation are not yet known, but based on current information about the reform plan there are a number of actions that individual taxpayers should consider taking before year-end.
Pay state and local taxes before year-end, if you won’t be subject to Alternative Minimum Tax in 2017. It is currently anticipated that the itemized deduction for state and local income and property taxes will be limited to $10,000 per year, beginning in 2018. If you itemize deductions, and do not expect to pay Alternative Minimum Tax (AMT) in 2017, you should consider paying any remaining 2017 state and local estimated income taxes before year-end, and prepaying 2018 property taxes to the extent possible. Note that any prepayments must go to the taxing authorities and cannot be left in escrow. Not all local jurisdictions will accept prepayments of property taxes, so you should check with your local tax authority.
Consider accelerating charitable contributions and other itemized deductions. It is currently anticipated that, beginning in 2018, the standard deduction will nearly double (to $12,000 for a single taxpayer and $24,000 for a joint return). As a result of the increase in the standard deduction and the restriction on the deduction for state and local taxes, many taxpayers who currently claim itemized deductions will instead be claiming the standard deduction after 2017. If you are in this category, you may want to accelerate your planned charitable contributions to 2017. You may also benefit from accelerating planned medical expenses into 2017, assuming that your level of medical expenses is sufficiently high to claim a deduction. Another benefit of accelerating your itemized deductions is that most taxpayers will have somewhat lower marginal tax rates in 2018.
Close on a large home or second home purchase. It is currently expected that, in the case of home mortgage loans incurred after 2017, the mortgage interest deduction will be limited to interest paid on a maximum of $750,000 of debt incurred to purchase a primary residence. Deductions would no longer be allowed for mortgage indebtedness in excess of $750,000, or on debt incurred to buy a second home, or on home equity lines of credit. Debt put in place before the end of this year would be “grandfathered,” however, so if you are about to close on the purchase of a primary residence with greater than $750,000 in debt or a vacation home, you should make every reasonable effort to close by year-end.
Sell high basis securities. The Senate bill would require taxpayers who sell marketable securities to recover based on a “first in, first out” basis (or in some cases, the average basis method), meaning that you would no longer be able to identify which lots of securities you were selling. If you are looking to rebalance your portfolio, consider doing so in 2017 while you can limit your capital gains by identifying high basis lots. Alternatively, if you have different lots of securities with differing basis, you may want to segregate the high basis lots from the low basis lots by transferring either the high basis or low basis lots to your spouse or a family limited partnership.
Contribute low basis securities. If you were planning, at some point, to donate stock to charity as an “in kind” charitable contribution, consider making the contribution in 2017, while you are still able to designate the specific shares of stock that you are contributing. You will want to contribute the shares with the lowest tax basis, provided the shares have been held for at least 12 months prior to the contribution. The same “first in, first out” rule that would limit your ability to identify high basis securities to sell also would limit your ability to identify low basis securities to give to charities. To maximize the additional tax benefit of giving appreciated securities (i.e. non-recognition of capital gain) consider gifting low basis stock this year.
Acceleration of long-term capital gain income. The tax rates imposed on long-term capital gains are not expected to change. There may be an advantage to recognizing long-term capital gains in 2017, rather than 2018, provided that you can prepay the state and local taxes triggered by such gain in 2017 and that you are not subject to AMT. As noted above, due to the anticipated $10,000 limit on state and local tax deductions, in many cases it will be better to pay state taxes in 2017, rather than 2018.
Deferral of ordinary income. Many taxpayers will have lower marginal tax rates as a result of tax reform. In such a case it will generally be better, where possible, to defer the recognition of ordinary income to 2018. On the other hand, due to the anticipated limits on state and local tax deductions, shifting income to 2018 may also result in the loss of the deduction for state and local income taxes on the deferred income. These two competing considerations must both be taken into account.
Like-kind exchanges. It is anticipated that the tax reform bill will limit the ability to engage in like-kind exchanges to exchanges of real estate that is held for investment or used in a trade or business. If you were planning on engaging in a like-kind exchange of other types of assets held for investment or use in a trade or business (such as artwork, cars or other collectibles), you will probably need to effect the exchange by the end of 2017.
While tax planning amid the festivities of the holiday season may not be a welcome subject, you may need to act now to preserve some important tax benefits. At the time of this writing, the House/Senate conference committee is still working on the final details of the tax reform proposal and not all details of the proposed legislation are known. Additional details should be forthcoming in the remaining days of the year, so you should be prepared to act quickly as the final details become known.