Tax Reform Update: A New Way to Reduce Taxes on Rental Income

by Amanda Han | BiggerPockets.com

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Even though the government was shut down, it looks like the IRS was still hard at work.

We are excited to let you know that there are some new details that the IRS recently released, which may be of benefit to real estate investors. Some of the most impactful pieces of new information released by the IRS were details on how rental income may qualify for the Section 199A tax benefit.

What is the Benefit?

In short, the new Section 199A benefit that came into effect for 2018 means that certain types of income may receive tax-free treatment on the first 20% of taxable profit. For example, if you are a landlord with taxable rental income of $100, the first $20 of that may be completely tax free and you only pay taxes on the remaining $80.

Who Does This Benefit?

For real estate related activities, we have always known that this benefit was available to realtors, real estate brokers, flippers, and real estate developers. Last week, the IRS finally released information to confirm that certain rental income may also be eligible for this tax break.

What’s New?

The recent IRS regulations provided “safe harbor” rules to define the criteria that could allow a taxpayer’s rental income to receive this 20% tax-free treatment. Safe harbor simply means that if the taxpayer meets these rules, their rental income should be eligible for the Section 199A benefit calculation. To qualify for the safe harbor rules, the taxpayer must meet all four of the following requirements:

• Have separate books and records for the rental real estate activities
• Have over 250 hours of rental service activities
• Have contemporaneous records to document these hours and services
• Attach a signed statement to the tax return to indicate the safe harbor requirement has been met

Related: PSA: Taxes Are the Biggest Cashflow Killer (With Examples)

The 250 hours of rental service activities may be aggregated amongst your eligible properties so that you may not need to meet the hours requirement for every single rental property separately. Eligible services include time spent on maintenance, repairs, rent collection, payment of expenses, and activities in order to rent the property.

The IRS also indicated that the eligible services do not need to be performed only by you as the property owner and can include services performed by employees, agents, and independent contractors, as well.

The other good news is that eligibility for the 20% tax-free rental income benefit is not connected in any way to real estate professional status. So, even if you are someone who does not qualify as a real estate professional, you may still be able to receive this tax benefit.

Even if you are a passive investor in an apartment syndication, your allocated rental income may be eligible for this tax benefit. This should prove to be a great tax savings tool for BRRRR investors and those operating in the high cash-flowing, short-term rental space.

It is important to keep in mind that just because the safe harbor rules are not met, it does not automatically mean the tax benefit is not applicable to rental income. There may be other ways to demonstrate eligibility outside of these safe harbor rules, as well.

It was not all good news, however. In the latest IRS-issued guidelines, it was indicated that triple net rental real estate and a rental property also utilized by the taxpayer as a residence during the year would not be eligible for this tax benefit. House hackers: this may be a tax benefit you will have to miss out on.

Related: IRS Code Section 199A: How the New 20% Pass-Through Deduction Affects Investors

What Does This Mean?

So, what does all this mean and does it impact you in any way? Well, the answer is, “It depends!”

The good news is that these new rules should not increase your tax liability in any way.

If you have net taxable rental income after expenses and depreciation, it is very likely that these new regulations will allow you to pay less taxes on the rental income.

Alternatively, if you are like most investors and expect to have a net rental tax loss after deducting expenses and depreciation, then this new benefit would likely not impact your tax bill for the year since there is no taxable rental income.

As you can see, these latest IRS regulations are designed to help reduce taxes for rental property owners. Make sure to work with your advisors this tax season to reduce your tax bill and keep more money to invest and grow.