In the pass-through tax deduction, the first 20% of certain types of income may be completely tax-free. So if you are a business owner and you make $100, the first $20 may be completely tax free and you only pay taxes on the remaining $80. 

But does rental income qualify for this 20 percent tax-free treatment(QBI)? 

The answer is not a simple yes or a no. 

If you run your rental business like a hotel business, B&B etc. and file Sch C, you’re able to claim the 20% tax QBI deduction.

However, if you run your rentals passively and file a Sch. E, then too you might be able to claim the deduction provided you can prove the following 4 Safe Harbor Requirements: 

1) You need to have separate books and records for your rental real estate taxation activities- Example, keeping separate bank accounts for each rental, separate books, not using bank account statements as accounting records help fulfill the requirement. 

2)  There needs to be over 250 hours of rental service activities done for the year: Here is a list of services that qualify for the 250-hour test: 

  1. i) Marketing the property for rent 
  2. ii) Negotiating and signing leases 

iii) Reviewing tenant applications 

  1. iv) Collecting rent 
  2. v) Managing the property
  3. vi) Dealing in the daily operations, maintenance, and repair of the property 

vii) Purchasing materials 

viii)  Supervising employees and contractors for the property

Important: The added benefit is that the 250-hour requirement does not need to come from tasks that are only performed by you as the investor. In fact, these tasks can be performed by your employees, agents, and contractors as well. If you hired a property manager and they spent at least 250 hours doing these tasks for you, you would meet the 250-hour safe harbor requirement.

3) You must be able to produce records and documents to prove these hours and services actually occurred: The third safe harbor requirement is that you must have records and documents to support the 250 hours of time that was spent. The timekeeping record can include time reports, logs, or other similar documents.

4) You need to attach a signed statement to the tax return to indicate the safe harbor requirement has been met: The last requirement under the safe harbor test is the easiest to meet. To claim the safe harbor and be able to have your rental properties qualify for the 20 percent tax break, you simply need to sign a statement and attach it to your tax return indicating to the IRS that you meet the safe harbor requirements. Keep in mind that this is a separate statement you would create to attach to the tax return. 

  • Income from Triple net lease properties do not qualify for the 20% QBI deduction.
  • Rental income generated from property that is being used as your primary home: If you rent out one of the rooms in your home, the rental income from that room would not qualify for this tax break.

At GavTax, Advisory services, we provide tax planning services and preparation services for businesses and individuals. We have a team of experienced individuals who would assist you complex tax issues that you might be facing with in your business or with your rental properties accountants who can help you save on taxes and get your finances in order. Contact us today to learn more!

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