In the United States, the tax code has been widely seen as favorable for landlords. From reducing taxes via depreciation (a non-cash expense) to having losses offset salary income to being able to shelter capital gains with a 1031 exchange, there are numerous tax benefits to landlording. With the Tax Cuts and Jobs Act of 2017, a major new benefit was added: the ability to deduct up to 20% of your net rental income from your income tax (“the 20% pass through tax break”).
What is a “20% pass through tax break”?
Woah! The term “20% pass through tax break” can be confusing. What does this mean?
From 2018 through 2026 (when this tax break is scheduled to end), this tax break may allow landlords to only be taxed on 80% of rental net income; hence the “20% deduction”. This deduction is only for “pass-through entities” – these are landlords who run their rental business as a sole proprietor, LLC owner, partner or S corp shareholder. A “pass-through entity” is a common business type where individuals pay their profits on their individual taxpayer rates.
Which landlords qualify for this?
When the 2017 tax cuts were passed, qualifying for the “20% pass through tax break” was originally complicated and confusing.
Fortunately, the IRS came out with a “safe harbor” rule which simplified the determination of whether a landlord can qualify for the tax deduction:
- Separate books and records must be maintained to reflect the income and expenses for each rental real estate enterprise.
- At least 250 hours of rental services must be performed each year with respect to each rental real estate enterprise. The safe harbor provides a list of rental services that qualify for this requirement.
- Records must be kept regarding the hours of all services performed, description of all services performed, who performed the services, and when the services were performed.
Additionally, there are income qualifications. The full 20% is available if your taxable income is less than $157,500 as a single filer or $315,000 if married filing jointly. If your income is higher, a complicated calculation by your CPA or tax software will calculate the amount that can be deducted.
To qualify for the “20% pass through tax deduction”, keep good records!
Good landlords keep track of income and expenses. It helps you understand what kind of profit or loss you are making, and is invaluable at tax time. The “20% pass through tax break” for landlords – and the important “safe harbor” provisions to qualify – reinforce the importance of good recordkeeping.
Fortunately, for the first safe harbor provision, there are great online tools that can help you track rental income and expenses. One of them, RentalIncomeExpense.com, is even free!