By Florin Filip

Landlords are among the biggest winners under the new tax law which took effect on January 1, 2018. The Tax Cuts and Jobs Act provides that the vast majority of residential landlords who own & manage rental property as sole proprietors, limited liability companies (LLCs), and partnerships, can take advantage of a new 20% tax deduction, in addition to all other rental-related deductions.  If you qualify for this deduction, you will effectively be taxed on only 80% of your rental income, leaving you more funds to invest towards building a secure future for you and your family.

Qualification for this new 20% deduction from income is only available to an enterprise classified as a trade or business.  The IRS has prescribed several “safe harbor” conditions under which a rental real estate enterprise will be treated as a trade or business. For the purpose of this safe harbor, a rental real estate enterprise is defined as an interest in real property held for the production of rents. It may consist of an interest in multiple properties, with the provision that commercial and residential rentals cannot be combined in the same real estate enterprise. Here is a summary of the requirements that must be satisfied for the safe harbor:

  1. Separate accounting records must be maintained for each rental real estate enterprise. 
  2. At least 250 hours of rental services must be performed for the year in question with reference to each rental real estate enterprise.

Rental services that may be counted towards the 250 hour requirement may be performed by owners or employees, agents, and/or independent contractors working for the owners, and may include: (i) advertising to rent or lease the real estate; (ii) negotiating and executing leases; (iii) verifying information contained in tenant applications; (iv) collecting rent; (v) daily operation, maintenance, and repair of the property; (vi) management of the real estate; (vii) purchase of materials for repairs; and (viii) supervision of employees and independent contractors.

  1. The taxpayer must maintain contemporaneous records documenting time reports and various logs registering the following: (i) hours of all services performed; (ii) a description of all services performed; (iii) dates on which such services were performed; and (iv) who performed the services.

Note: Triple net lease agreements and vacation rentals are not eligible for the “safe harbor” rules.

If the safe harbor requirements are met, you still have to pass one more hurdle in order to qualify for the new 20% pass-through rental income deduction. The IRS has set income brackets that limit the access to the 20% tax deduction.

For 2018, taxpayers who enjoy annual taxable income above $415,000 if filing married filing jointly (above $207,500 for all other taxpayers) may still be entitled to a pass-through deduction, but the deduction cannot exceed the greater of: (i) 50% of their applicable share of the W-2 employee wages paid by the rental business; or (ii) 25% of their share of the W-2 wages paid by their business, plus 2.5% of the original purchase price of the depreciable property used in the production of rental income.

Considering the complex details of the 20% pass-through deduction available to rental owners, working with our team of experienced CPAs might be the key to significant tax savings for you and your family!