The Qualified Business Income (QBI) Deduction
One of the key components of the landmark tax overhaul passed in 2017, called the Tax Cuts and Jobs Act (TCJA), was a new provision that allows taxpayers to deduct 20% of “qualified” business profits from their income, subject to certain limitations.
In a simplified example, if a married couple has $200,000 of taxable income and $75,000 of that is from a pet grooming business they own, they would be entitled to deduct $15,000 (20% of $75,000) from their income, reducing their taxable income to $185,000 and reducing their federal tax liability by over $3,500.
In order for a business activity to qualify for the full version of this 20% “Qualified Business Income” (QBI) deduction, the activity must be a qualified “trade or business” as defined by the tax code. It also must not be what is considered a “specified service trade or business,” which is a category not explained in depth here—but one that includes businesses in the legal, accounting, financial services, medical, consulting, athletic, or entertainment industries, all of which may receive limited or restricted QBI deductions. Our CPAs in Mid-Missouri are here to give you more information on the QBI deduction in this week's blog. If you have any questions, our Central Missouri CPA firm is here for you. Call Wilson Toellner CPA today. We have four locations throughout Mid-Missouri, all can be found on our website at www.WTCPA.com.
As the tax-saving implications of this provision were considered, tax professionals asked the IRS for guidance on whether rental real estate profits, historically treated differently than other small business income, would qualify for this new deduction. That guidance was provided, and it creates opportunities for owners of rental real estate—but in order to fully realize these opportunities and maximize this deduction, rental real estate investors should learn a few new rules and concepts, and be prepared to discuss them with their tax professionals.
One new concept related to this deduction is the rental real estate enterprise, which is an interest in real property held for the production of rents. It may consist of an interest in one or more properties. Likely the easiest way for a rental real estate investor to receive a deduction for 20% of their rental real estate profits is to meet a set of safe harbor requirements set forth by the IRS. Those safe harbor requirements are as follows:
• Separate books and records are kept for each rental real estate enterprise
o Bank accounts from multiple enterprises should not be co-mingled
• At least 250 hours of rental services are performed in the tax year for the enterprise
• Records are kept for all services, detailing the following:
o Hours, description, and date of services performed
o Who performed the services
• A single enterprise cannot contain both commercial and residential rental real estate
The services above are not limited only to those provided by the taxpayer and can include services provided by contractors and/or property managers. These records must be available at IRS request. “Services” can include advertising, negotiating leases, verifying tenant information, collecting rent, operating/maintaining property, purchasing materials, supervising employees and contractors. Services may not include financial management activities, acquiring property, reviewing financial statements, planning for improvements, or traveling.
In order to claim the safe harbor, a specific statement is attached to the taxpayers’ tax return. The safe harbor claim is made annually, as applicable.
If the taxpayer does not meet the requirements of the safe harbor, rental real estate profits can still qualify for the QBI deduction, but the facts and circumstances of the situation would need to support that the rental real estate enterprise otherwise qualifies as a trade or business—which is more difficult to prove. It is also important to note that profit or loss from self-rental activities is always treated as QBI-eligible; triple-net lease profit or loss (unless part of a self-rental agreement) is never QBI-eligible.
The TCJA created a multitude of tax-saving opportunities for business owners and rental real estate investors. Understanding these concepts and communicating with your tax professionals in Mid-Missouri to first determine how this provision impacts you, then to consider the composition of your rental real estate enterprise(s) and create a documentation plan to support future deductions just might save you money at tax time. For more information, please call Wilson Toellner CPA today.
Written By: Adam Wolfe, CPA
In a simplified example, if a married couple has $200,000 of taxable income and $75,000 of that is from a pet grooming business they own, they would be entitled to deduct $15,000 (20% of $75,000) from their income, reducing their taxable income to $185,000 and reducing their federal tax liability by over $3,500.
In order for a business activity to qualify for the full version of this 20% “Qualified Business Income” (QBI) deduction, the activity must be a qualified “trade or business” as defined by the tax code. It also must not be what is considered a “specified service trade or business,” which is a category not explained in depth here—but one that includes businesses in the legal, accounting, financial services, medical, consulting, athletic, or entertainment industries, all of which may receive limited or restricted QBI deductions. Our CPAs in Mid-Missouri are here to give you more information on the QBI deduction in this week's blog. If you have any questions, our Central Missouri CPA firm is here for you. Call Wilson Toellner CPA today. We have four locations throughout Mid-Missouri, all can be found on our website at www.WTCPA.com.
As the tax-saving implications of this provision were considered, tax professionals asked the IRS for guidance on whether rental real estate profits, historically treated differently than other small business income, would qualify for this new deduction. That guidance was provided, and it creates opportunities for owners of rental real estate—but in order to fully realize these opportunities and maximize this deduction, rental real estate investors should learn a few new rules and concepts, and be prepared to discuss them with their tax professionals.
One new concept related to this deduction is the rental real estate enterprise, which is an interest in real property held for the production of rents. It may consist of an interest in one or more properties. Likely the easiest way for a rental real estate investor to receive a deduction for 20% of their rental real estate profits is to meet a set of safe harbor requirements set forth by the IRS. Those safe harbor requirements are as follows:
• Separate books and records are kept for each rental real estate enterprise
o Bank accounts from multiple enterprises should not be co-mingled
• At least 250 hours of rental services are performed in the tax year for the enterprise
• Records are kept for all services, detailing the following:
o Hours, description, and date of services performed
o Who performed the services
• A single enterprise cannot contain both commercial and residential rental real estate
The services above are not limited only to those provided by the taxpayer and can include services provided by contractors and/or property managers. These records must be available at IRS request. “Services” can include advertising, negotiating leases, verifying tenant information, collecting rent, operating/maintaining property, purchasing materials, supervising employees and contractors. Services may not include financial management activities, acquiring property, reviewing financial statements, planning for improvements, or traveling.
In order to claim the safe harbor, a specific statement is attached to the taxpayers’ tax return. The safe harbor claim is made annually, as applicable.
If the taxpayer does not meet the requirements of the safe harbor, rental real estate profits can still qualify for the QBI deduction, but the facts and circumstances of the situation would need to support that the rental real estate enterprise otherwise qualifies as a trade or business—which is more difficult to prove. It is also important to note that profit or loss from self-rental activities is always treated as QBI-eligible; triple-net lease profit or loss (unless part of a self-rental agreement) is never QBI-eligible.
The TCJA created a multitude of tax-saving opportunities for business owners and rental real estate investors. Understanding these concepts and communicating with your tax professionals in Mid-Missouri to first determine how this provision impacts you, then to consider the composition of your rental real estate enterprise(s) and create a documentation plan to support future deductions just might save you money at tax time. For more information, please call Wilson Toellner CPA today.
Written By: Adam Wolfe, CPA
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