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On August 16, 2022, President Biden signed the Inflation Reduction Act into law. It’s a landmark bill that will result in significant changes across a wide variety of industries, impacting many elements of the U.S. economy.
The legislation includes $430 Billion in new government spending on programs that invest in domestic energy production, climate change technology, and lower prescription drug costs. The spending is offset by a predicted $740 Billion in new taxes and savings in existing programs.
Coming in at 730 pages, there’s a lot in this legislation––one of the biggest government spending programs in years. But what are the key takeaways for real estate investors?
Carried Interest Didn’t Get Touched
In the run-up to the passage of this legislation, it seemed likely that the carried interest loophole was going to be eliminated.
This tax provision taxes the income of professionals like private equity firm partners, real estate syndicators, and hedge fund managers at the capital gains rate, rather than the ordinary income rate, provided they hold their earnings for at least three years. Successful investors use this loophole to save millions of dollars on their personal income taxes.
The movement to close the carried interest loophole has been around for close to fifteen years, but as of yet, no legislation has made any meaningful attempt to close it. While it seemed likely to be closed in this bill, it hasn’t been––and that’s good news for real estate syndicators.
The IRS Is Doubling in Size
One key headline from the legislation is the nearly $80 Billion in new funding for the IRS over the next ten years. Adjusted for inflation, that’s a more than 50% increase in the agency’s annual budget.
In recent years, the IRS has been underfunded and understaffed, and as a consequence, audit rates have been at historic lows. This new funding enables the IRS to almost double its workforce, adding 87,000 new agents directed to focus on tax enforcement.
This is expected to give the IRS the capacity to conduct an additional 1.2 Million audits and we expect these to be targeted toward small business owners and the middle class. To fulfill their remit of raising an additional $203 Billion in taxes over the next ten years, it’s likely the IRS is going to go after low-hanging fruit first.
So, what is this low-hanging fruit? In our view, there are really two areas real estate investors need to pay the most attention to.
The first area of focus for the IRS is likely to be disqualifying tax positions that individuals are using without the proper documentation. If you’re using real estate professional status or the short term rental loophole, it’s vital you accurately document your time to ensure you have the documentation required to back up your tax position. Consider using time-tracking software to ensure accuracy.
The second main area of focus for the IRS will be disqualifying tax deductions that taxpayers claim without the correct documentation. If you’re taking a big tax deduction, but don’t have the receipts or invoices to back that up, it’s likely that it’ll be disqualified in the event of an audit. That can lead to you owing back taxes, penalties, and interest––not to mention the hassle and expense of dealing with an audit.
While enforcement is going to be more strict, now is absolutely still the time to embrace advanced tax strategies. With bonus depreciation starting to phase out in 2023, there’s still time to have a cost segregation study done to realize maximum benefits. Other strategies like securing real estate professional status and operating short-term rentals still remain as powerful as ever.
How Should Real Estate Investors React to the Inflation Reduction Act?
As we noted earlier, the IRS has been understaffed and underfunded for years. But with the passage of this bill, the tide is turning. If you’ve been coasting by without proper documentation for years and haven’t been audited, now is the time to make a change.
Leveraging advanced tax strategies to save money on your taxes really starts in one place: bookkeeping. The IRS is going to be looking for flaws and missing records, but provided you have adequate documentation to back up your tax positions, you have nothing to worry about.
If you feel like it’s time to upgrade your approach to bookkeeping, our real estate tax specialists at Hall CPA are here to help.
By partnering with our outsourced real estate accounting practice, you can have our team set up your accounting and bookkeeping system in Quickbooks Online. Once everything is set up, you can either manage it yourself or have our team handle everything for you on a monthly basis. To learn more about these services, contact us today.
Want to learn bookkeeping for yourself? Our Quickbooks Online Bookkeeping Bootcamp walks you through the best practices for staying on top of your bookkeeping using automated technology. These masterclasses are held every quarter, and you can learn more about them (and receive discounted pricing) by subscribing to the free Tax Smart InvestorTM newsletter.