Real estate investing can complicate tax returns, so it’s important to know all the possible deductions a property owner can take to maximize the return on her investment.
While a good tax accountant or attorney can help an investor to take advantage of sometimes obscure tax benefits, so can a good property manager. A property manager can help investors to avail themselves of the qualified business income deduction (QBI), which was introduced as part of the Tax Cuts and Jobs Act (TCJA) of 2017.
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Also known as the Section 199A deduction or the 20 Percent Pass-Through Deduction, the QBI lets owners of so-called pass-through businesses deduct up to 20 percent of the income from a qualified trade or business if the owners meet certain thresholds.
Figuring out if an investor qualifies for the QBI deduction is not simple matter because the proposed regulations rest on a tax law question that doesn’t have a definitive answer: Is owning rent-generating property a business or an investment? Rather than directly answering this question, the IRS provides a set of criteria to qualify for the deduction.
How to meet the QBI criteria
Meeting these criteria means that the individual(s) or entity puts in enough of a particular type of work to qualify for the QBI deduction.
“It’s tricky,” says Thomas Stepp, Mynd’s head of investor offerings, “and that’s coming from someone who’s been in this space for a long time. I don’t think the QBI is clear to anyone but an accountant, and if you asked three different accountants about the same scenario, you would probably get three different answers.”
The law also requires those who want to take this deduction to spend a good amount of time running their business, so it may be most applicable for investors with a large portfolio that they self-manage.
“You can definitely qualify, but they make it like dragging yourself across glass to get it,” says Stepp, “so the time invested may outweigh the savings returned.”
Given how complicated the QBI deduction is, it is prudent to consult with a real estate tax professional. Mynd’s property management services can be helpful because of how accurately they can document the work it takes to maintain your rental properties.
Pro tip: The QBI expires in 2025 unless Congress acts to renew it.
What is the QBI deduction and how does it work?
The qualified business income deduction allows eligible self-employed people and small business owners to deduct up to 20 percent of their qualified business income. In general, the filer’s total 2021 taxable income must be less than $164,900 for single filers or $329,800 for joint filers. In 2022, those figures go up to $170,050 for single filers and $340,100 for joint filers.
When filers are over that limit, complex IRS rules determine whether the business’s income qualifies for deductions. The QBI deduction is for filers who have what is referred to as “pass-through income” — business income they report on their personal tax returns.
Some of the legal entities that can claim the QBI deduction are:
- Sole proprietorships
- S corporations
- Limited liability companies (LLCs)
What are the requirements to qualify for QBI?
There are four main requirements to qualify for the QBI deduction.
- Investors must make sure to have separate records for their investment properties.
- If they have owned the home for less than 4 years, they must document that they have spent 250 hours on rental services, which can include, for example, speaking to tenants, doing maintenance, or screening renters. If they have owned the home for more than 4 years, they must show that they have spent 250 hours on rental services in three of the five consecutive years.
- They must maintain time logs to show how those 250 hours were spent.
- All documents demonstrating the above must be attached to each tax return.
Not all income qualifies. QBI excludes:
- Interest income
- Capital gains/losses
- Income earned outside the U.S.
- Certain wage and guaranteed payments made to partners and shareholders.
Again, a knowledgeable tax accountant can advise real estate investors on whether they are eligible to take advantage of the QBI deduction, and a Mynd property manager can help them to prepare for tax time.
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