While not technically related, pass-through deductions and casualty losses can easily confuse even the most seasoned landlords. This article explains how and if you can take advantage of these tax strategies.
The 20% Pass-Through Deduction Explained
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$160,700, if single, or $321,400 if married for 2019.
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.
Safe Harbor for Landlords
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. This requires that ALL conditions are met:
- The property is held directly by the individual or through a disregarded entity by the individual or pass-through entity seeking the pass-through deduction. For example, 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.
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.
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.
Casualty Losses Explained
A casualty loss is considered a “sudden, unexpected, or unusual event” that causes property damage or loss. These events commonly include:
- volcanic eruptions
- terrorist attacks
If one of your rental properties is completely destroyed in one of the above scenarios, the amount of the loss you can claim is equal to your adjusted basis in the property.
If you receive a reimbursement from your insurance company for exactly the amount of your property’s adjusted basis, then you recognize no gain or loss. If the reimbursement is more than your adjusted basis, then you must recognize a gain. If it is less, then you recognize a loss in the amount of the difference.
In the event of a gain, you can avoid recognizing it by simply reinvesting the proceeds into a property that is “similar or related in service or use.” You have two years from the end of the tax period in which the gain was received to find a suitable replacement.
Your rental property has an adjusted basis of $114,000 in 2019. A wild fire strikes, completely destroying the property.
In Scenario A, the insurance company cuts you a check for $114,000. No loss or gain is recognized.
In Scenario B, the insurance company pays you $126,000, the property’s fair market value (FMV). You would have to recognize a gain of $12,000.
However, you purchase a similar replacement property that costs $126,000 in 2019. In this case, you do not have to recognize the gain, but your basis in the new property would be $114,000, the adjusted basis of the original property.
Check out more topics on rental property tax deductions:
- Rental Property Accounting Basics
- 9 Common Landlord Tax Deductions
- Business Travel Expenses for Rental Owners
- Rental Property Depreciation Overview
- Capital Improvements vs. Repairs and Maintenance Expenses
- Passive Activity Limits and Passive Losses
- Capital Gains, Depreciation Recapture, and 1031 Exchange Rules
- Short-Term Rentals and Related Taxes
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 guide is 100% accurate, complete, and error-free. We assume no liability or responsibility for any errors or omissions in this guide.