In the United States, the tax code has been widely seen as favorable for landlords. For instance, landlords can reduce their taxes by way of depreciation, and they can offset salary income with losses. In addition, they can shelter capital gains with a 1031 exchange. The Tax Cuts and Jobs Act of 2017 introduced a significant benefit of a 20% pass through tax deduction for landlords. This deduction enables landlords to deduct up to 20% of net rental income from income tax.
What is the 20% pass through tax deduction?
From 2018 through 2026, the 20% pass through tax deduction allows landlords to be taxed on 80% of rental net income. Specifically, this deduction is only for pass-through entities where landlords run their rental business as a sole proprietor, LLC, or S corporation. Overall, a pass-through entity is a common business type where individuals pay their profits on their individual taxpayer rates.
Who can qualify?
The IRS has a safe harbor rule which simplifies the determination for how landlords can qualify for the tax deduction:
- Maintain separate records to reflect the income and expenses for each rental real estate enterprise.
- Perform 250 or more hours of rental services each year for each rental real estate enterprise. The safe harbor provides a list of rental services that qualify for this requirement.
- Keep detailed records on the hours and descriptions of all services performed.
The amount landlords can deduct depends on income qualifications. For example, landlords can deduct the full 20% if taxable income is less than $157,500 as a single filer or $315,000 if married filing jointly. However, for higher income levels, a calculation will determine the deduction amount. In other words, tax software or accounting professionals will need to perform the calculation.
To qualify, keep good records!
Well organized landlords track rental income and expenses, and good data helps landlords understand how well the rental business is doing. In conclusion, the 20% pass through tax deduction for landlords and the safe harbor provisions to qualify reinforce the importance of good recordkeeping. There are online tools that help track rental income and expenses. One of them, RentalIncomeExpense.com, is even free!