Are You Ready For The New Tax Changes?

 2017 seems to have flown by.

Personally, I welcomed the birth of my son, renovated and moved into a house that was previously being used to sell methamphetamines, and also managed to sneak in a short visit to India. On the whole, quite an eventful year!

Looking at the markets, we were surprised by the continued strength. I mentioned in July that while we were close to the end of this bull market, we shouldn’t quit on it just yet.

And sure enough, the SP 500 index (which measures the performance of the largest publicly traded companies in the US) is up nearly 10% since July. Every single asset class is also positive for the year.

Year-to-date asset class returns:

Emerging Market Stocks   31%

Developed Market Stocks  25%

US stocks (SP 500)    21%

US mid-cap stocks   19%

US small-cap stocks   16%

US REITS   3%

International REITs   14%

US Bonds   3%

Emerging Market Bonds   10%

HighYield Bonds   16%

Floating-rate Bonds   0.6%

Gold   10%

Gold Mining Stocks   8%

Commodities   5%

Most of the US stock market performance is based on the widely anticipated tax bill that both houses finally agreed upon and is likely to get signed into law next week.

The biggest boost to investors is the reduction in the corporate tax rate from 35% to 21%. Taxation on foreign income will also be completely revamped. Corporations are sitting on $2 trillion in cash overseas which they were unwilling to repatriate at the prior 35% tax rate. But now there’s no reason not to bring that money back to the US. This should provide a nice, but one-time, boost to corporate coffers and share prices.

But on the individual side, things are less rosy. I’m not a CPA, but I’ll do my best to parse the tax bill.

The promised simplification of the tax code and repeal of the AMT did not happen. Instead, the tax code has  added even more complexity and also picked certain industries to be winners and others to be losers.

In general, it seems that 75% of tax filers will see some minor benefit. If you live in a state with high taxes and property prices, your benefit will be a lot lower.

On the bright side, the standard deduction has doubled and the tax brackets have declined. So a lot of people who used to itemize can now take the standard deduction and save a little bit of money. They won’t save any time because they still need to calculate if itemization will provide a larger tax deduction.

Unfortunately, this came at a cost.

The amount you can deduct for state and local income taxes, and property taxes will be capped at $10,000 a year. This is quite a reduction for a two-income family living in a high-tax and high-property-price state like California or New York who have been itemizing their deductions.

Additionally, the mortgage deduction on new home purchases has been lowered from $1 million to $750,000. While this seems like a high exemption, with the median list price for homes in Los Angeles at $749,000 this cap is expected to hurt real estate values in California. Maybe that’s a good thing if you’ve been waiting to buy a home.

Tax Tip to home owners in high-income tax states:  You most likely pay your property tax in two installments each year. You already made a payment recently, and the second half is due now, with a deadline early next year. If you already haven’t done so, make your second payment before the end of the year. This will allow you to claim the deduction in 2017 – you won’t be to deduct it if you make the payment next year. (Don’t try and prepay next year’s property taxes – you still won’t be able to deduct those and your check will likely be returned).

A major outcome of the tax bill will be normalization of deductions between renters and home owners. The US government used to subsidize and encourage home ownership though the mortgage interest and property tax deduction. Now that this incentive to own your home has been greatly reduced, we can expect it to hurt property values. The actual impact won’t be known for a few years, but if less people become homeowners then more people will be renters…creating an opportunity for rental real estate investors.

Seeing as how Trump makes millions off rental income, I’m not surprised a benefit to real estate investors made it’s way into the tax bill. There’s no mortgage cap on investment property, the depreciation schedule has improved, and the maximum tax bracket on rental income has dropped. There’s also the pass-through deduction, where real estate owners may to deduct 20% of income.

Coupled with a potential drop in real estate prices, it might actually be a good time to start investing in real estate.

To see how the new tax bill be will impact you personally, use this nifty calculator  from CNN.

Of course, use it with a grain of salt. The final version of the tax bill won’t be known for a while, so a lot of it is just speculation.

Speaking of speculation, Bitcoin fever is infecting investors all over the world.

Bitcoin was a novel concept. The world’s first digital, decentralized cryptocurrency. It offered privacy, autonomy of government and central bank control, and the ability for peer-to-peer transactions, thus removing middle men. The blockchain technology is revolutionary and is likely to change society.

However, the technology doesn’t need to be coupled with a currency to be valuable. And ownership of bitcoin doesn’t bestow any ownership of the technology.

In reality, its functioning less like a currency and more like a speculative investment.

For a currency to be viable, first and foremost it needs to be stable.

Bitcoin prices have increased 2,000% in the past year,  and 34 million percent from 2011! Until yesterday morning that is, when it dropped 30% overnight.

It also doesn’t have widespread adoption, and buyers aren’t using it to transact. While early adopters were happy to transact, more recent buyers are hoarding it, hoping that they will be able to offload it at a higher price later on. There are also reports of people taking out mortgages and maxing out their credit cards to “invest” in bitcoin.

Even buyers who do want to conduct business in bitcoin are facing steep transactional costs, which have risen steadily as the price of bitcoin has exploded. It average transaction cost is currently about $25. Using bitcoin for anything other than high-price purchases is becoming impractical.

The much-touted privacy is turning into a liability as the exchanges that facilitate the use of Bitcoin have been repeatedly hacked and hundreds of millions of dollars worth of bitcoin have been stolen. If your bitcoin is ever lost or stolen from an exchange, unlike traditional banks or credit cards, you have no recourse.

There are currently nearly 1,500 different cryptocurrencies. It’s hard to predict which one will finally be the last man standing and attain “reserve” cryptocurrency status.

The technology will eventually see widespread adoption and may eventually replace physical currency. But we’re not there yet. We still in the pioneer phase. And similar to early investors in Pets.com and other e-retailers who got wiped out in 2000, people jumping in today are unlikely to reap the rewards commensurate with the level of risk.

Remember the old saying: Pioneers get arrows, Settlers get gold!

The goal of investing is improve your financial scenario using disciplined, and replicable process. Don’t risk your financial future taking speculative bets.

If you’d like to discuss your investment performance, retirement plans, or you’d like a complimentary portfolio review, use this contact form and we’ll schedule a time to talk.

Wish you all a Merry Christmas!

Nirav