Pass-Through Deductions for Real Estate Investors

2020-02-17

Pass-Through Deductions for Real Estate Investors

The Tax Cuts and Jobs Act (TCJA) of 2018 brought about a massive tax cut for owners of “pass-through” businesses.

Pass-through businesses, the largest segment of registered businesses, are ones in which the business entity pays no tax, but instead the earnings “pass-through” to the owner(s) who pay the taxes on their personal tax returns. For property owners who qualify, up to 20% of their rental income can be deducted from their income taxes. Another option allows for a deduction of 2.5% of the investment plus 25% of employee wages.

Do I Qualify?

ust because you have cash flow from a rental property doesn’t necessarily mean that the IRS classifies your dealings as a business, at least not for tax purposes. Your rental activities may produce income and expenses, which led to some confusion as to who was eligible for pass-through deductions. To eliminate any uncertainty, the IRS created guidelines for landlords with limited real estate holdings.

One such action was the passage of the Safe Harbor rule that would allow smaller rental businesses to benefit and meet the requirements for pass-through deductions.

What You Need To Qualify for the Pass-Through Deduction

To meet the basic requirements of the pass-through deduction, you must operate your business through an approved legal entity such as a: Sole Proprietorship, S-Corp, Limited Liability Company (LLC), Limited Liability Partnership (LLP), or partnership. Take note that there are income limits as well $160,725 for single filers or $321,400 for married couples. These income limits are adjusted annually to account for inflation.

Not all rental businesses, even if they turn a profit, are considered qualifying businesses according to the IRS. The Safe Harbor rule was designed solely to provide pass-through deductions for businesses that may not have qualified in the past. The Safe Harbor rule was created to give smaller businesses protection from the IRS and to provide the same benefits as larger operations. The Safe Harbor rule allows you to benefit from pass-through deductions if:

1) Individual accounting records are maintained for each rental property; (even if you’re operating a rental business as a side business, this is something you should probably be doing anyway)

2,) You and/or any employees perform a minimum of 250 hours annually on the property. These may include, but are not limited to:
-daily operations/maintenance
-marketing and advertising 
-managing/supervising employees or maintenance contractors 
-tenant interviews, verifying credit reports or running background checks 

3.) The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents.” These records should include hours, dates, and descriptions for any services performed on the property. Reports and logs for documentation are not required to be filed with your annual tax returns, but should be kept as evidence and verification should you be audited. 

3.)The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents.” These records should include hours, dates, and descriptions for any services performed on the property. Reports and logs for documentation are not required to be filed with your annual tax returns, but should be kept as evidence and verification should you be audited. 

3.)The taxpayer maintains contemporaneous records, including time reports, logs, or similar documents.” These records should include hours, dates, and descriptions for any services performed on the property. Reports and logs for documentation are not required to be filed with your annual tax returns, but should be kept as evidence and verification should you be audited. 

It’s no secret that reducing your gross income by being able to take advantage of all tax deductions lowers your overall tax burden, but even owning one single-family rental can allow you to benefit. Since not all rental “businesses” will qualify for pass-through deductions, if you can meet the qualifications and show proof, the tax savings can be significant. As a reminder, always check with your tax professional to avoid any unwanted interaction with the IRS. 

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