REAL ESTATE, INVESTMENTS Sept. 2019

Rental Real Estate Tax Strategies – more advanced
Real estate rental properties can be a fine tax shelter and a satisfying way to build retirement income if you know what you are doing. However, watch out for the complexities. The last WealthWISe discussed some of the basics. This article will get into more complex matters. These include a deduction of up to 20% of net rental income, taxation of gain at lower rates if you miss the traps for flippers, “phantom income,” PAL rules that limit rental operating losses, and the self-employment tax on rentals that provide significant services. Read more.

20% QBI Deduction. Is It For You? The new 20% deduction for domestic income from pass-throughs can apply to landlords if they have moderate incomes, but it is not automatic. Partnerships, S corporations, or sole proprietorships can qualify and can deduct up to 20% of profits from their taxable income. However, the rental activity must involve regular, continuous and substantial activities intended to make a profit. This does not mean a triple net lease. You may qualify for a safe harbor if you are an owner that devotes at least 250 hours to the rental activity. If your taxable income does not exceed a threshold of $315,000 (joint filers), or $157,500 (all other taxpayers), there are no further limits to this deduction. The deduction phases out as income exceeds $160,700 ($321,400 for a joint return).

Capital gain Rental properties held 12 months or more qualify for long term capital gain treatment. They are generally taxed at half of normal tax rates or less.

Dealer trap. Loss of capital gain trap: A property held primarily for sale does not qualify for capital gain treatment. So a real estate flipper, who is in the business of buying and selling properties, may not qualify.

Special rules must be strictly followed for the sale to qualify as a “like kind exchange rules.” Get professional advice to qualify.

“Phantom gain” is a taxable gain that occurs even though you have no equity because the property’s adjusted basis was decreased by depreciation or where you previously refinanced and took out cash.

Vacation Homes What about property you use personally and rent, such as a vacation home? This situation is complicated. You must divide all deductions between personal and rental use. The IRS and the courts disagree on how. The specifics are beyond the scope of this article.

Passive Loss Rules. Congress enacted the Passive Activity Loss rules (PAL) to fight tax shelters, and they automatically apply to most rental activities. Under PAL you must suspend rental losses until there is offsetting income from PAL’s or its sale. However, an exception allows rental property owners to deduct up to $25,000 of PAL in which you actively participate. Active participation means significant management functions but may include using a property manager. The $25,000 limit phases out as modified adjusted gross income exceeds $100,000, so at $150,000 in MAGI you deduct nothing. Married taxpayers filing separate returns may not use the $25,000 allowance unless they live apart during the entire taxable year.

Real Estate Pros If you spend most of your working time in the real estate business, rental real estate losses are exempt from the passive loss rules. We are talking about a majority of work hours and more than 750 hours per year. This means that if you have a full time job elsewhere, you most likely cannot qualify.

Bed And Breakfast Trap Watch out! If the operation of a rental property involves significant services, the IRS could treat it as a trade or business, subject to the self-employment tax (an extra 15%). For example a Bed and Breakfast. This rule is most dangerous to short term rentals like Airbnb.

About Wis Laughlin

I help clients with tax preparation and IRS representation, estate planning, and complex contracts, including LLC's. As a former IRS tax attorney in their National Office. Law.com picked Wis in 2017 and several prior years as one of the Top Tax and Estate Lawyers in Tennessee. I am your advocate, not your accountant. I don't tell you what you can't do. I show you how to do it.
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