The tax reform, known as the Tax Cuts and Jobs Act (TCJA), recently added some benefits to both your residential and commercial real estate rentals.
Did you know your qualified business income from your real estate rentals creates a possible 20% tax deduction with no effort on your part?
And if you want less taxable income, the TCJA gives you enhanced bonus depreciation and new avenues for Section 179 expensing.
Before this was put in place, if you had net taxable income from a pass-through business entity, the net income was simply passed through to you and taxed at your personal rates.
NERD LANGUAGE: What is a “pass-through business entity?” It’s a sole proprietorship, an LLC treated as a sole proprietorship for tax purposes, a partnership, an LLC treated as a partnership for tax purposes, or an S corporation.
For 2018 and beyond, the TCJA established a new tax deduction based on a non-corporate owner’s qualified business income (QBI) from a pass-through business entity. The deduction generally equals 20% of your Qualified Business Tax Deduction (QBI), subject to restrictions that can apply at higher income levels.
While it is not entirely clear at this point, the new QBI deduction is used to offset a profitable real estate rental that you own via one of the aforementioned pass-through entities.
For qualifying property placed in service in tax years beginning in 2018, the TCJA increased the maximum Section 179 deduction to $1 million.
If you’re an avid BullitProof reader, you know the Section 179 deduction privilege allows you to deduct the entire cost of eligible property in Year 1.
For real estate owners, eligible Section 179 property includes any improvement to an interior portion of a nonresidential building. The only qualification is that improvement needs to be placed in service after the date the building was placed in service.
The TCJA expands the definition of eligible property to include expenditures for nonresidential building roofs, HVAC equipment, fire protection alarm systems, and security systems.
Finally, the TCJA expands the definition of Section 179 even further to include eligible property depreciable tangible personal property used predominantly to furnish lodging.
This would mean beds and other furniture, as well as appliances. It further includes other equipment used in the living quarters of a lodging facility like an apartment, dormitory, or other places where sleeping accommodations are provided and rented out.
The TCJA increases the first-year bonus depreciation percentage to 100%! This is a 50% increase to what it was before!
Unlike the old 50% deduction, which was for new property only, the new 100% deduction is allowed for both new and used qualified property.
The TCJA eliminated the separate definitions of qualified leasehold improvements, qualified restaurant, and qualified retail improvement property. Instead it provides one category for qualified improvement property that is eligible for Section 179 expensing and bonus depreciation.
If your rental property throws off a tax loss in the early years, and most do this so don’t worry if you fall into this category, things get complicated. The passive activity loss (PAL) rules will usually apply.
NERD LANGUAGE (again): You get two for one in this article. Lucky you! PAL Rules are what is used to prevent investors from using losses from income producing activities from which they’re not materially involved.
Whether or not the PAL rules apply to you, the TCJA adds a new hurdle to deducting business losses regardless of where they come from. For tax years 2018-2025, you cannot deduct an excess business loss in the current year.
An excess business loss is the surplus of your aggregate business deductions for the tax year over the sum of your aggregate business income and gains for the tax year plus $250,000. Keep in mind, if you’re married this number comes to $500,000. The excess business loss is carried over to the following tax year and can be deducted under the new rules for net operating loss (NOL) carryforwards.
The TCJA continues prior law and allows real estate owners to upgrade their real property portfolios without taking a federal income tax hit by using a like-kind exchange, also known as a Section 1031 exchange. With the like-kind exchange, you essentially use the tax rules to sell your old property and then buy the replacement property.