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).
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.
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
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
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.
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.
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.