Renting out property can create a retirement income stream that is Uncle Sam friendly. The federal tax law is replete with breaks for landlords, and the 2017 tax law created a new write-off that many landlords can take for their Schedule E rental income.
The new tax break falls under the special 20% deduction for individual owners of “pass-through entities.” Self-employed individuals and owners of S corporations, partnerships and LLCs can now write off 20% of their qualified business income, or QBI.
QBI is your allocable share of income less deductions from a trade or business. Special rules and limitations apply to individuals reporting taxable incomes before the QBI deduction in excess of $321,400 on joint returns and $160,700 on single returns.
The QBI rules are one of the hardest provisions in the 2017 tax law to navigate, according to Joel Grandon, enrolled agent and president of the National Society of Accountants. There is no hard and fast rule for determining whether your real estate rental activity is a trade or business, other than a safe harbor, which is difficult to meet. It’s best to seek out the advice of a good tax preparer, Grandon says.
Qualifying for the QBI Break
There are two ways to qualify rental income as QBI. The first way is if the rental activity rises to the level of a trade or business. This determination depends on a taxpayer’s specific facts and circumstances. Some relevant factors are type of property (residential or commercial), extent of day-to-day involvement by the lessor or his agents, lease terms and number of rentals.
A second way to qualify rental income as QBI is to meet an IRS safe harbor. At least 250 hours in a year must be devoted to the activity by the property owner, employees or independent contractors. Time spent on repairs, tenant services, property management, advertising, collecting rents, negotiating leases and supervising workers counts. Hours put in for arranging financing, constructing long-term capital improvements, and driving to and from the property aren’t included.
Taxpayers who use the safe harbor must meet strict recordkeeping requirements and attach an annual statement to their returns, as detailed in IRS Revenue Procedure 2019-38 (opens in new tab). Meeting the safe harbor lets you treat the rental activity as a business for QBI purposes.
Following a set of best practices can help to solidify the tax break. Because of the safe harbor’s stringent 250-hour minimum and strict recordkeeping requirements, Grandon says it may be easier to meet the case law’s trade or business standard, which doesn’t always require a lot of time spent on the activity. It depends on each taxpayer’s facts, so it’s possible to have substantially less than 250 hours and still be in a business.
Grandon advises that those who want to treat their rental activity as a business adhere to these best practices: Keep separate bank accounts for the activity. Track your time and the time of everyone whom you pay to do work on the property, plus a description of the work. Keep expense receipts, and insure the property. And send 1099 forms by January 31 to anyone you pay $600 or more in a year for services and isn’t a corporation; file copies of the 1099s with the IRS.
Can you qualify for the QBI break if you only own one rental home? Steve Fishman, author of Every Landlord’s Tax Deduction Guide (Nolo, $40), says yes, depending on the facts and circumstances. Fishman says that if he owned a single rental property that generated income, he would take the 20% write-off. He concedes, however, that the more rental properties you own, the stronger your trade/business argument will be.
Treating the rental income as QBI and taking the 20% deduction won’t change the way you report rental income on your 1040 return. Real estate rental income is usually reported on Schedule E. Also, the rental income generally isn’t subject to self-employment tax. If you qualify, you take the 20% QBI deduction on line 10 of the 2019 Form 1040 and attach either Form 8995 (opens in new tab) or 8995-A (opens in new tab), depending on taxable income.
Joy is an experienced CPA and tax attorney with an L.L.M. in Taxation from New York University School of Law. After many years working for big law and accounting firms, Joy saw the light and now puts her education, legal experience and in-depth knowledge of federal tax law to use writing for Kiplinger. She writes and edits The Kiplinger Tax Letter and contributes federal tax and retirement stories to kiplinger.com and Kiplinger’s Retirement Report. Her articles have been picked up by the Washington Post and other media outlets. Joy has also appeared as a tax expert in newspapers, on television and on radio discussing federal tax developments.
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