As real estate investors, we’ve heard a lot this year about the new tax benefit for our businesses referred to as the 20% pass-through deduction. Simply put, this incentive allows you deduct 20% of your business income. Sounds great right? At Stessa, we’ve teamed up with the experts over at The Real Estate CPA to answer the most common FAQ surrounding this new tax incentive—the meaning of ‘safe harbor’. Let’s take a closer look.
What is the 20% pass-through deduction?
The Tax Cuts & Jobs Act of 2017 introduced a new 20% pass-through deduction allowing certain business owners to deduct 20% of qualified business income if your taxable income is below $157,500 if single or $315,000 if married. Should your taxable income be above these thresholds, a complicated calculation will be used to determine the amount of this deduction. Luckily your tax professional or tax software will handle that for you.
What does safe harbor mean?
If you still have taxable income from your rental properties after following the strategies explored in this guide, you may qualify for the 20% pass-through deduction under the following safe harbor, which requires that ALL conditions are met:
- The property is held directly by the individual or through a disregarded entity by the individual or passthrough entity seeking the pass-through deduction (e.g. a person who owns a single-member LLC that holds a rental property qualifies).
- Commercial and residential real estate may not be part of the same enterprise.
- Separate books and records are maintained to reflect income and expenses for each rental real estate activity or enterprise (a separate real estate enterprise may constitute multiple properties as long as it is all commercial or all residential).
- 250+ hours of rental services are performed for the enterprise (see details below).
- You maintain contemporaneous records, including time reports or similar documents, regarding: a) hours of all services performed, b) description of all services performed, c) dates on which such services are performed, and d) who performed the services.
What qualifies as rental services?
Rental services include advertising to rent, negotiating and executing leases, verifying tenant applications, collection of rent, daily operation and maintenance, management of the real estate, purchase of materials, and supervision of employees and independent contractors. Services performed by owners or employees, agents, or contractors all count toward the 250 hours.
What if I don’t meet the safe harbor criteria?
Note that even if your rentals don’t meet the criteria for the above safe harbor, that doesn’t necessarily mean they won’t qualify for the 20% pass-through deduction. Regardless of whether your activity qualifies for the described safe harbor, if you plan on taking this deduction, you’ll have to issue Form 1099 for all independent contractors to which you paid over $600 during the year.
Note: Rental property owners are generally not required to file or send 1099s to independent contractors unless you plan to take the 20% pass-through deduction, provide substantial services to guests, or qualify as a real estate professional for tax purposes.
While reasonable efforts were taken to furnish accurate and up-to-date information, we do not warrant that the information contained in and made available through this article is 100% accurate, complete, and error-free. We assume no liability or responsibility for any errors or omissions in this article.