Controllables - Key Market Aspects_ 08.19.205
Following up on our "Knowables" piece from late July, which summarized the key changes in tax law, we wanted to revisit how these updates might affect investors. While there was some chatter about the changes, the reality is that for most investors, the impact is quite minimal outside these two items below. Sure, it's nice that Social Security benefits are no longer taxed, but in the grand scheme, this change won't have a significant effect on the lifestyle or investment decisions for our typical investor.
That said, the tax law revisions do highlight a couple of important areas. Let’s dive deeper into the two primary takeaways from these changes:
1. Capital Gains vs. Ordinary Income: A Clear Advantage for Investors
One of the standout features of the updated tax laws is the continued preferential treatment of capital gains. For most investors, this remains a critical distinction in how their income is taxed. The current top rate for capital gains is 20% for joint taxable income over $600,050, which is significantly lower than the 37% tax rate applied to ordinary income over $751,600 for joint filers. This tax differential creates a clear incentive for investors to hold assets those returns include capital gains, not simply ordinary income.
Beyond just the tax rate, the real power of capital gains taxation often lies in the flexibility it offers. Investors generally can control when they realize their gains. This means that, in years when taxable income is particularly low (say, after a business exit, or a year with fewer income-generating activities), investors can strategically choose to realize capital gains at a lower effective tax rate—or potentially avoid paying taxes on the gains altogether.
2. Bonus Depreciation and the Power of Capital Expenditures
The second area where the new tax laws could have a profound impact is in relation to bonus depreciation, particularly for those involved in real estate or expanding their business. The enhanced deductibility for capital expenditures via bonus depreciation may allow real estate and business owners to accelerate deductions for investments in property or equipment.
For businesses and startups looking to scale, this can provide immediate relief by allowing them to write off a large portion of their capital expenditures upfront, rather than waiting over several years. This upfront deduction can significantly reduce taxable income in the year the expenditure occurs.
But the real goldmine in these changes is for real estate investors. With cost segregation studies and proper identification of capital expenditures, real estate owners may be able to speed up their depreciation schedules. For example, certain components of a property—such as assets with shorter lives - may qualify for accelerated depreciation, which could potentially create a meaningful immediate tax deduction.
If you’re a real estate investor and are considering upgrades or improvements to your property, now is the time to talk to a tax professional.
In Conclusion
For most investors, the recent tax law changes will likely have only a modest effect. However, those with the right approach - whether through strategic use of capital gains or by taking advantage of accelerated depreciation in real estate - can still leverage these updates to their advantage. The bottom line: Your investment strategy should include a focus on capital gains and the business plans for your real estate investments should almost certainly be looking toward taking advantage of these new depreciation rules.
This material is for informational purposes only and is not investment advice or a recommendation. All investments involve risk, including potential loss of principal. Past performance is not indicative of future results. Consult your financial advisor before making any investment decisions.