Does Your Rental Property Qualify for the New 20% Section 199A Tax Deduction?
May 14, 2019
Could the 2018 tax filings have been more complicated? Probably, but it was the most confusing in over thirty years!! In the new set of laws governing business profits and losses, real estate rental activities received massive attention. Why? Because the majority of rentals have always been what is defined as a “passive” activity rather than an active “trade or business” activity. Other types of passive income are interest and dividends. Income from passive activities is not subject to self-employment tax (social security). Which is why many older investors look to rentals as a means of steady income in their retirement years.
The new law, Tax Cuts and Jobs Act (TCJA), added a very attractive provision for “business” profits. Section 199A provides for a 20% deduction of the profits as an adjustment to gross income if the activity qualifies as a “trade or business.” Also, profits and losses from all of your qualified business income activities are netted before the 20% deduction is calculated. Any remaining QBI losses are carried forward to offset future profits – not so attractive. What made this confusing for preparers was the question, “What rental activities qualify for this provision?”
First, we learned the provision does not apply to income of C corporations. This entity type was given a flat 21% tax rate, so Congress decided to give other types of business structures the 199A deduction. So sole proprietors, partnerships, and S corporations can use this new law. Partnerships and S corporations pass their income or loss through to the partners and shareholders, but the determination is made at the entity level if the activity qualifies for the deduction. The K-1’s from these entities have entries on the form and supplemental information the individual taxpayer uses to calculate the deduction.
So now we are back to the “trade or business” classification. Congress loves to use a “safe harbor” rule, meaning if you meet a certain amount of activity (250 hours here) then the activity qualifies as a “trade or business” and you can use the deduction. The other qualifying factor is if the activity rises to the level of a “trade or business.” Now the phrase “facts and circumstances” comes up. Meaning that each taxpayer’s rental activity has to be reviewed separately. The general consensus is that one residential rental doesn’t qualify but multiple residential or commercial rentals will.
Many investors use companies to manage their rentals. These would still qualify if the owner makes the management decisions and can document their involvement, not hours. So it appears that it is easier to use the determination the rental rises to the level of a “trade or business” than the safe harbor of 250 hours.
Another bonus is that qualifying as a “trade or business” does not trigger the self-employment tax. And if there are multiple rental units, these can be grouped to show sufficient management involvement to qualify (this is not related to the real estate professional designation and the grouping election).
If you have rental activities, did you qualify for the 199A deduction? If the rental units were held in a partnership or S corporation, did the K-1 disclose the supplemental information needed to use the deduction?
If you would like help discerning whether your rental properties qualify for the new 20% Section 199A tax deduction, our Certified Tax Coaches are available to work with you. Contact our team at 850-973-4353 or email firstname.lastname@example.org for more information.
Pam Schoelles, Certified Tax Coach | Advanced Tax Planning Expert at Schoelles & Associates, Inc.