By Jacob A. Stewart JD
Many business owners own one or more rental properties. Since the new tax laws went into effect in 2018, landlords have been wondering if their rental property income qualifies as a trade or business for the purposes of the 20% deduction. Last week, the IRS finally issued some additional guidelines to help landlords know how to qualify for the deduction.
Under the new guidelines, the IRS has created a safe harbor for “real estate rental enterprises.” If at least 250 hours of services are performed each tax year on behalf of the enterprise, separate books and records are kept for the rental activities, and a special statement is filed each year with the tax return indicating all of this, landlords will fall into the safe harbor category and will be able to take a 20% deduction on profits from property rentals.
In determining the 250 hours, services performed by owners, employees, or independent contractors (such as maintenance, repairs, rent collection, paying expenses, providing services to tenants, and efforts to rent the property) all count. Time spent by the owner arranging financing, looking for new properties, reviewing financial statements, and traveling to and from the property(ies) DOES NOT count towards those hours.
Properties that are under a triple-net lease or that are used by the taxpayer DO NOT fall under the safe harbor guidelines, but may qualify under another definition.
A triple-net lease is one where the tenant is in charge of paying all of the expenses of the property (in addition to rent), such as real estate taxes, building insurance, and maintenance. Many commercial leases are created this way. The good news is, triple-net leases can be renegotiated so that the landlord is in charge of paying these expenses. Obviously, the landlord would increase rent accordingly, so it is important for the landlord to understand what those expenses are in order to readjust the rent to reflect those expenses.
In theory, it is possible that income from a property with a triple-net lease could still take the 199A deduction, but the landlord would have to be very careful to comply with all requirements under IRC Section 162 for operating a trade or business.
Weigh Your Options Carefully
If your rental activities are not currently netting any taxable income (many rentals actually show a tax loss each year), or if it would not be worth documenting 250 hours per year in order to qualify for the deduction, then it probably doesn’t make sense to make any changes. For some people, though, qualifying for the 20% deduction under Section 199A could save a lot of money in taxes. If you feel like qualifying for the deduction would benefit you, it is important to work with a tax professional who can guide you through the rules and help you make your decision.
This article is meant to provide general information and should not be construed to contain individual tax or legal advice. Feel free to contact me at 801-923-8350 or email@example.com with any questions or for more information.
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