Now that we are approaching our second year under the The Tax Cuts and Jobs Act of 2017 (the “Tax Act”) we have some money saving tips.
Tip # 1 – Take Advantage of the 20% Real Estate “Trade or Business” Deduction
There is a 20% tax deduction for all business owners and in particular those who invest in real estate. Real estate investors can conform their activity with their investment properties to become a “rental real estate trade or business” and take advantage of a tax deduction of up to 20% of “net profits.” The best part of this deduction is that it is exempt from the “phase-out provisions”. 1
To qualify, you must keep daily detailed records for each “rental real estate activity”. 2 There are two caveats: 1) You cannot use any rental as your own residence for even one day, and; 2) You cannot use a “triple net” lease.
Tip # 2 – Determine the Best Entity for your Trade or Business
In our last Newsletter, C Corporations (“C Corps”) were awarded the 1st Place Medal for benefiting the most from the new Tax Act. But what about the shareholders of C Corps? How did shareholders of C Corps fare?
After the shareholder of a C Corp pays income tax on their wages and other distributions they fall behind owners of “pass-through” entities because the income is subject to a second tax at the shareholder level. In contrast, “pass-through” entities pay no income taxes. The income is only taxed once at the shareholder level.
Conclusion: Use S Corps or LLCs as your entity of choice for your “trade or business”.
1.“Pass-through” entitles including S Corporations, partners, and sole proprietors qualify for a deduction of up to 20% of “Qualified Business Income” or the “operating profits” of a Trade or Business. IRC Section 199A contains all the complicated rules governing this deduction including income limits for the phasing out of the deduction for certain Specified Service Businesses including most professional service providers. This reduces the effective tax rate for “pass-through” entities from 39.6% to 29.6%. Real estate rental services can be performed by the taxpayer or their employees, agents or by their independent contractors to include the following services: advertising, tenant info verification, collecting rent, negotiating leases, managing, purchasing materials, and supervision of employees and independent contractors. Excluded are services such as financing or investment management activities or time commuting to and from the property.
2. Including time reports, logs, or similar documents, regarding the following (i) hours of all services performed; (ii) description of all services performed; (iii) dates on which services were performed and (iv) who performed such services. Such records are to be made available for inspection at the request of the Service. Starting in 2023, you will need to be averaging 20 hours a week in “rental real estate activity” to claim the deduction.
We hope these tax tips are helpful!