With the recent passage of the federal Tax Cuts and Jobs Act (TCJA), taxpayers are beginning to learn how much they stand to benefit from the new law. One of the groups of individuals that stands to benefit is landlords. If you own rental property, learn how the new tax law helps landlords, and what you should do to maximize your tax advantage.
Many landlords own their rental property in their sole name (as sole proprietors) or through a partnership or a limited liability company (LLC). As such, profits earned from renting the property "pass through" directly to the owners. These profits are taxed on the owners' individual income taxes, and are taxed at the owners' individual tax rates. Rental income and expenses are reported on IRS Schedule E and filed along with the owner's tax return.
The TCJA creates a new, and significant, deduction for those who earn rental income through sole proprietorships, partnerships, or LLCs. Most such rental activity qualifies, for tax purposes, as a business. If yours falls into this category, you will now be able to deduct from taxable income an amount equal to 20% of your net rental income. You will still be able to deduct all the expenses related to operating your rental property that you were able to claim previously. The effect of this new deduction is that you will be taxed on only 80% of your income from rental properties.
This deduction takes effect in tax year 2018 and remains in effect until January 1, 2026 (this "sunset" provision affects many aspects of the new tax law).
In order to qualify for the maximum deduction of 20%, you must meet two criteria: you must operate your rental property as either:
Your total taxable income for the year must not exceed certain limits ($157,500 for a single filer, or $315,000 for a married couple filing jointly). If your income exceeds these limits, the amount of the deduction begins to phase out, disappearing altogether for single filers with income above $207,500 or a married couple filing jointly with income above $415,000.
Even if your income exceeds the amounts listed above, you can still benefit from the change in the law. Single filers with income exceeding $207,500 and married couples filing jointly with incomes exceeding $415,000 can still benefit from the new law.
Individuals who have income over $207,500 or couples with income exceeding $415,000 can still claim the pass-through deduction of up to 20% of rental income so long as the deduction does not exceed either:
The depreciation period for residential property is no less than 10 years and as much as 27.5 years, and the 2.5% deduction can be taken throughout the depreciation period. Since many rental businesses do not have W2 employees, the latter option is preferable for those landlords.
As an example, if Joe, a landlord who is single, has taxable income of $300,000, and has no employees, he would be able to claim a pass-through deduction of 2.5% of his depreciable basis in the condo he rents out. This is equal to the purchase price of the property less the value of the land. If Joe's basis in the condo is $200,000, his maximum deduction is $5,000 (2.5% of $200,000).
If you are a landlord, this pass-through deduction is available to you even if you do not itemize on your income tax return. While it does not reduce your adjusted gross income (AGI), it will reduce your taxable income and can result in a significant tax savings.
If you are a businessperson, you may be familiar with Section 179 of the tax code. This section permits business owners to deduct the cost of personal (as opposed to real) property that they use in their rental business. This deduction is taken all in one year rather than over several years.
Beginning in 2018, the maximum deduction is $1,000,000, double the 2017 maximum deduction of $500,000. The deduction is reduced to the extent that the cost of property placed into service during that year is above $2,500,000.
As significant as the increase in the deduction amount is, there is another change to the law that landlords might find even more helpful. Section 179 has never been able to be used to deduct the cost of personal property placed in residential rental units: think furniture and appliances. The TCJA has wiped out this restriction, meaning landlords can deduct even more than previously. In addition, bonus depreciation will apply for the first time to used as well as new property under the TCJA.
There's more good news for landlords in this new tax law. While most business owners are required to pay self-employment taxes, comprised of Medicare and Social Security taxes on their net business income, most landlords have always been exempt from this requirement. There was debate in the House of Representatives of removing this exemption, but, fortunately for landlords, the exemption remained in the final version of the bill.
To learn more about the Tax Cuts and Jobs Act and how it may benefit you, we invite you to contact our law office.
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