I’m hopeful that when you read that catchy title you asked yourself, “What business deduction?
Saying “business deduction” to anyone in business is like saying pizza tastes good. A premise that (I don’t think) anyone can argue with, but not very specific.
Now that I have your attention, I’ll make this crystal clear: we’re talking about our (somewhat) new friend the Qualified Business Income Deduction (QBID).
Real estate investors may be eligible for the qualified business income (QBI) deduction, also known as Section 199A deduction, which was created by the Tax Cuts and Jobs Act of 2017. Millions of small businesspeople have been enjoying this additional reduction in taxable income since tax year 2018.
This deduction allows eligible taxpayers to deduct up to 20% of their qualified business income from a partnership, S corporation, or sole proprietorship, as well as any income from rental real estate that is considered to be a trade or business.
QBID is subject to certain limitations and restrictions, and the eligibility and exact amount of the deduction may vary depending on the specific circumstances.
Is There any Special Trick to Getting It?
Not really. If you are not what the IRS refers to as a real estate professional, you may qualify for the deduction with as little as 250 hours of active involvement in your investments per year.
That’s about 21 hours a month. You can do that standing on your head, I imagine.
The IRS guidelines say some version of this; the activities must be regular, continuous, and substantial, and the primary purpose must be to generate a profit.
Once you have determined your eligibility for the deduction, ensure that you’re checking the appropriate box on your return schedule, stating that you actively participated in your real estate business during the tax year.
The QBI deduction is 20% of the net income, plus 20% of qualified real estate investment trust (REIT) dividends and qualified publicly traded partnership (PTP) income.
One thing to keep in mind though is that if your 1040’s taxable income (excluding the business income 20% calculation) is lower than your net business income, then you are limited to 20% of taxable income.
I am not a fan of this particular piece of IRS mathematical trickery, but not liking it doesn’t make it go away.
If wishing made things so, business would be easier for everybody, right?
A Word about Net Losses
Passive loss limitations established by the IRS limit the amount of passive losses that a taxpayer can deduct from their taxable income.
In the case of rental real estate, passive loss limitations apply to rental income that is considered passive activity income.
The passive loss limitation rules state that a taxpayer can only deduct passive losses from passive income, such as rental income from passive activities.
If a taxpayer does not have enough passive income to offset their passive losses, the excess losses can be carried forward to future tax years and can be used to offset passive income in those years. But all is not totally hopeless.
If you or your spouse actively participated in a passive rental real estate activity you can deduct up to $25,000 of loss from the activity from your nonpassive income. This special allowance is an exception to the general rule disallowing the passive activity loss.
Additionally, you may carryforward your losses indefinitely. This basically allows you to save significantly on the taxation of your passive activity (but, of course, not your other sources of income) until you have the profitable rental revenue portfolio you’re working toward.
Real estate professionals enjoy an exception to this rule. If you meet certain requirements, you can claim passive losses without limitation, not least of which is a requirement to participate activity in the field 750 hours a year.
The good news for you folks is that this is ALL of your real estate activity, not just passive income.
If you’re new to the wonderful world of investment real estate, having this particular arrow in your quiver is an encouraging consideration for the next several years.
I hate to end on a low note, but do keep in mind that, in the absence of replacement legislation, the Tax Cuts and Jobs Act sunsets on the last day of 2025. So…if you’re thinking the time may be right for investment?
You may be right!