How to Obtain the New 20% Tax Deduction for Rental Properties
New Section 199A of the Internal Revenue Code gives many business owners a 20% personal tax deduction from the overall net income of the business. For instance, if the business has a net income of $100,000, a $20,000 deduction may be available (thus reducing the taxable income of the business to $80,000). While there are many variations/permutations with respect to this 20% deduction (income phase-outs, wage limitation issues, service business limitations, etc.), this deduction can apply to those holding real estate as an investment. And it is important to realize that all taxpayers can claim this deduction as long as their personal income is less than $157,500 (if single) or $315,000 (for taxpayers married filing jointly).
The IRS has recently issued regulations on this matter. In Revenue Procedure 2019-7, the IRS offers a “safe harbor” in helping to determine if a rental activity (or multiple rentals if the taxpayer chooses to aggregate them into one business, with the understanding that commercial properties cannot be grouped with residential properties) will qualify for the Section 199A 20% tax deduction. You must meet all three of the following for the safe harbor to apply:
- separate books and records are maintained for each rental activity (or the combined business if grouped together),
- 250 hours or more of “rental services” are performed per year for the activity (or combined activities), AND
- the taxpayer maintains contemporaneous records, including time reports or similar documents, regarding:
(1) the hours of all rental services performed:
(2) a description of all services performed,
(3) the dates on which such rental services are performed, and
(4) who performed the services.
Basically, this means recording and maintaining good records on the who, what, where, when and why of any time spent on a rental property. Fortunately, many different types of real estate services will qualify for the “time” analysis. For example, “rental services” includes trying to rent the property and advertising; negotiating and executing leases; reviewing and verifying tenant applications and determining which tenant to lease to; the collection of rents; daily operation and maintenance; management of the real estate/rental activity; the purchase of supplies and materials; and the supervision of employees and independent contractors (including maintenance workers).
Note that this safe harbor does NOT apply if you personally live in the rental property for more than 14 days per year. In addition, the safe harbor cannot be used if you rent the property on a triple net basis. A triple net lease is one in which you as the landlord require the tenant to pay for all real estate taxes, insurance, and maintenance.
Also understand that simply because property does not qualify for safe harbor relief does not mean that this business cannot qualify for the Section 199A deduction. You still have the opportunity (although much more difficult) of convincing the IRS that your rental activity rises to the level of a trade or business and is not simply an investment activity.
This section of the Internal Revenue Code has numerous different parameters and is extremely complex. It is strongly recommended that any rental property owner discuss this (and their overall tax situation) with a tax planning professional so that a maximum tax benefit may be obtained! Your tax situation is unique and this general article is not intended to replace an analysis of your personal/business tax situation.