Relying on the Rental Real Estate QBI Safe Harbor

In response to a recent question we wrote this article to clarify some elements relevant to many of our clients who have rental real estate in their investment and business portfolios.

2017’s Tax Cuts and Jobs Act amended the Internal Revenue Code in many ways, including a provision for a “qualified business income” (QBI) deduction.  This article discusses the availability of this deduction.

Applying this deduction to the case of taxpayers with personally-owned rental property was challenging and the IRS created a “safe harbor” allowing taxpayers to have a tool upon which they can rely in making claim to this deduction.  The safe harbor applies to “rental real estate enterprises” which are discussed below.  In order to rely on it, the response to all of the following questions must be “yes.”

  • Is the property held in a “rental real estate enterprise?”
    • Is the property “held to generate rental or lease income?”
    • Is the property an “interest in a single property or interests in multiple properties?”
    • Does the taxpayer personally own or own the property(ies) in question through a disregarded entity (Example:  A single member LLC)?
  • Does the taxpayer keep separate accounting books and records that reflect income and expenses for each rental real estate enterprise? Note that we assist clients with these requirements.
  • 250 Hours:  For rental real estate enterprises that have been in existence less than four years, did the taxpayer spend 250 or more hours performing rental services in the year of the deduction?  Note that an IRS auditor will request records of this time spent in the event of an audit.  For other properties (beyond the four years), was 250 hours documented in at least three of the past five years?
  • Does the taxpayer maintain contemporaneous (not created after the fact) records, including time reports, logs, or similar documents, regarding the following:  Hours of all services performed; description of all services performed; dates on which such services were performed; and who performed the services?  Note that we recommend our clients use a mobile app to document these requirements.
  • Is the taxpayer willing to attach a statement to the taxpayer’s return filed for the tax year in question that the taxpayer is relying on the safe harbor?

If the responses to the preceding questions are all “yes,” an interest in a rental or rentals can be treated as a single trade or business for purposes of this deduction.  We want to note that even if the safe harbor does not apply because one of the questions above has a “no” response, the QBI deduction may still be available through the 199A provisions themselves.  Using this approach may increase audit risk and involve additional documentation burdens.  The preceding link provides a wealth of information on QBI in general.

This information is provided for discussion purposes only and does not constitute tax advice.  Readers should discuss their specific situations with us or another qualified tax professional.

Year-End Tax Review

As we come to the end of 2017, there’s a final chance to take advantage of remaining 2017 opportunities and to begin positioning for 2018. If the House and Senate agree on and pass a tax code revision this year (and the President signs it), we’ll publish our take on what that means for the various components of our clientele. This article focuses on remaining 2017 opportunities.

Fund Your IRA

Even if you participate in your employer’s 401(k) plan, consider setting up (if you don’t already have one) and funding an IRA this year (or making a contribution if you have one). For many of our clients, your IRA contribution won’t be tax deductible and they won’t qualify for a Roth IRA. But, in 2017, the opportunity to make a non-deductible contribution remains open for everyone and clients have the right to change their minds later on and recharacterize that contribution to a Roth.

We’ve written previously about the wonder of self-directed IRAs for opening up the investment horizon to rental real estate, tax liens, promissory notes, and other options not available through brokerage-administered IRAs. All that remains true and we’re working on an update.

For clients who are hitting their maximum deferred compensation limits of $18,000 for 2017, reducing any unmatched amounts to allow for an IRA contribution makes sense since clients then have more control of their investment options. This is even true for those who have access to the Federal government’s Thrift Savings Program — we recommend that any amounts saved for retirement beyond 5% of pay be contributed to an IRA rather than the TSP (yes, we’ve taken the ultra-low-cost TSP administration fees into account in making the recommendation). The same logic applies to 401(k) plans in general. Clients should plan on making an IRA contribution in 2018 and adjust their payroll withholdings accordingly.

Charitable Contributions

Charitable contributions remain deductible for 2017 so we recommend clients take a few minutes to review their charity list from previous years and to take a look at funding some new ones. Many states have a “double dipping” list of charities and even tax credits that make giving to specific types of charities a dollar-for-dollar reduction up to the taxpayer’s state liability. In Arizona, for example, donations to charities that qualify as “Qualifying Charitable Organizations” that support foster care or the working poor reduce taxpayer liability in the amount of the contribution up to $400. Arizona allows these contributions to made up to the return due date of April 17, 2018.

We hope folks don’t forget local schools contributions as an option either especially if there is a local tax credit available in their states.

Tax-Free Medical Funds

Many clients set aside pre-tax funds in the various options (MSAs, HSAs, FSAs). Review those if yours has a “use-it-or-lose-it” component and get to the dentist or whatever. If an individual or family has met their health plan’s deductible, getting elective procedures or tests done this year will save, especially if meeting the deductible next year isn’t likely. Think about how much to set aside for 2018 and remember that FSAs now have the ability to roll over limited amounts rather than simply losing them.

Tax Loss Harvesting

If clients have had a windfall sale during the year, now’s the time to sell portfolio holdings at a loss, especially if a similar (but not identical) asset (not the same one) is available for immediate purchase with the freed up funds. Clients should avoid triggering the IRS’s wash sale rules by repurchasing the exact same asset just sold.

Prepaying Tuition

This may be the last time this one works. The Hope or Lifetime Learning credits are still available for 2017.

Small Business Deductions

This is the true engine of wealth generation — investing in productive assets. Major asset acquisitions that can still be deferred to 2018 may get a better treatment by doing so. For most filers, though, this won’t make a difference and we recommend taking the deduction in 2017.

Summary List

This list summarizes the article’s points and adds items to consider for your upcoming filing.

  • Penalties for early withdrawal of savings
  • Alimony paid
  • Student loan interest
  • Prescription eyeglasses, contacts, and hearing aids
  • Crutches, canes, and orthopedic shoes
  • Medical transportation costs
  • Cost of alcohol or drug abuse treatments
  • Charitable contributions
  • Local and state income taxes
  • Personal property taxes or real estate taxes
  • Points paid for a mortgage or refinancing a home
  • Unreimbursed employee business expenses
  • Mileage and other expenses associated with volunteer work
  • Casualty and theft losses
  • Tax preparation software and tax-preparation fees

As always, our articles are not intended to be specific advice. We publish them to stimulate discussions with each client so please contact us with your thoughts and questions regarding the points you found interesting or relevant to your situation. We’re awaiting your email or message.

Arizona Small Business Support

This post is the first in the small business category (tag).

While our income tax services for individuals and businesses are available regardless of the filer’s location (with some exceptions), our small business services are pretty much constrained to Arizona. That’s because state and local ordinances largely shape the cost of optimizing a comprehensive package of business support services. Based on the legal requirements, we’ve woven together partners and technologies that allow us to front to you, the microbusiness entrepreneur, the support you’ll need to get your good idea up and running. And, if you’ve been trying to do it all yourself, consider sluffing off some of the business process functions to us so you can dedicate more time to your passion. That’s not to say that we can’t help out-of-state firms (we actually have a presence in several states and even an overseas office), we can but probably not as comprehensively as in Arizona where we know the business climate and legal framework, especially human resources, quite well. Contact us if you think we can help aspects of your out-of-state business.

Our technology partner, CPA Network Solutions, provides everything related to software, computers, phone systems, and the internet, along with some other CPA firm-specific services we use in-house. Have you wanted access to world-class human resources software and advice? That’s available through CPA Network Solutions. The same with a professional, internet-based phone system. Paradise Hills Accounting provides our bookkeeping services (we use them too) including payroll and payroll tax filings (that stuff is really tricky!). Your books are always available online in one of several applications we use including the Quickbooks and Wave families. Those partners leave us free to do what we do best, organizing your tax life as the foundation of integrated financial planning (saving/investing, retirement planning, estate planning, risk management/insurance). Got the idea?

We are also ninjas in getting stuff done like business entity organization at rock bottom prices (you do most of the work, we point you in the right direction). Most legal documents, for example, are available from paralegal services — we use LawDepot, but there are many others. Having familiarity with stock-in-trade items like business filings with the Arizona Corporation Commission leaves us free from excessive legal fees. Bottom line, most divorce documents are just cut-and-paste versions of the last divorce the attorney sold; the divorce is only new to the former couple.

We’ll have a download available soon on how to start your own business in AZ so look for that. It will include how to interact with our partner web, so your business is up and running as soon as possible.