Would someone who owns business real property in their own name (not in an LLC or Partnership or corporation) and files on Schedule E face the $10,000 cap.
Could the same appropriate real estate be placed it into an LLC to avoid the $10,000 cap on state and local taxes by using Schedule C or filing a separate return for the LLC?
The cap on state and local taxes continues to be confusing to taxpayers. I think that’s because when lawmakers and pundits talk about the cap, they tend to talk about it in absolutes.
The short answer to your question is no, the cap doesn’t apply under those facts. But let me walk you through how I got there. Whenever I have a question about the application of a specific provision, I find it helpful to go directly to the source. In that case, that means checking out the language in the statute. So, let’s do it. The applicable section is 11042 of the new tax law.
The bit that most people care about is here:
the aggregate amount of taxes taken into account under paragraphs (1), (2), and (3) of subsection (a) and paragraph (5) of this subsection for for any taxable year shall not exceed $10,000 ($5,000 in the case of a married individual filing a separate return).
In other words, section 164 of the Tax Code is amended to cap the aggregate of certain state and local taxes, including real estate taxes. But the statute doesn’t stop there. It goes on to say:
The preceding sentence shall not apply to any foreign taxes described in subsection (a)(3) or to any taxes described in paragraph (1) and (2) of subsection (a) which are paid or accrued in carrying on a trade or business or an activity described in section 212.
That makes clear that the cap doesn’t apply to state and local taxes which are paid or accrued in carrying a trade or a business (you could probably stop there) or an activity described in section 212. Just to make sure that we’re not missing anything, let’s check out section 212. This is classic tax law construction so be patient, we’re getting to our answer. Section 212 says:
In the case of an individual, there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year:
(1) for the production or collection of income;
(2) for the management, conservation, or maintenance of property held for the production of income; or
(3) in connection with the determination, collection, or refund of any tax.
So that rental real estate you have? You’re using it to produce income, right? Then, BOOM. Not subject to the cap. The cap is intended to apply to those state and local taxes claimed on a Schedule A. For more on Schedule A changes, click here.
That means that to claim a deduction for those business-related taxes, you don’t have to do anything else: There’s no need to put real estate into an LLC, incorporate, or shift to another schedule. For more on whether incorporation makes sense under the new tax law, click here.