THE NEW QUALIFIED BUSINESS INCOME DEDUCTION FOR LANDLORDS
George Wilson Adams CPA MBA
February 26, 2019
The Kings of Keys have a new tax deduction starting in 2018
Introduction
The new tax law (the Tax Cuts and Jobs Act) provides for a write-off called the Qualified Business Income ("QBI") deduction available to businesses and landlords. This deduction is claimed on line nine, page two of the 2018 Form 1040. In this article I will discuss the QBI deduction available to residential and commercial landlords.
QBI for Landlords
QBI for landlords is basically the net rental profit earned from leasing residential or commercial property. Rental profit is rent income minus all expenses and is typically reported on Schedule E or on Form 8825 for business entities such as LLC's and partnerships. (Hopefully not on a corporate tax return - corporations should never own real estate.) If you have a net rental loss then it's unlikely you will receive a QBI deduction.
Calculating the QBI Deduction
2018 IRS Publication 535 (starting at page 49) and page 37 of the 2018 instructions to Form 1040 contain detailed guidance on how to calculate this deduction. Click on the following links to access these resources:
https://www.irs.gov/pub/irs-pdf/p535.pdf
https://www.irs.gov/pub/irs-pdf/i1040gi.pdf
The QBI deduction is 20% of QBI subject to the following three major limitations:
(1) Taxable Income - you can't claim a QBI deduction that exceeds your (modified) taxable income.
(2) Wage Limitation - this limitation does not apply if your taxable income is under $157,500 (single filing status) or $315,000 (joint tax returns.) If your income does exceed these thresholds then use Worksheet 12-A in 2018 IRS Publication 535.
(3) 2.5% of the cost basis of business property. This limitation is actually favorable to larger landlords and the mechanics of applying it result in allowing landlords to benefit from a QBI deduction.
A Simplified Example
Assume there is a residential landlord who has a 2018 net rental profit of $100,000 shown on his Schedule E. His filing status is single and he has no other income or expenses. His QBI deduction would be determined as follows:
| Net rental profit | $ | 100,000 |
| Less: Standard deduction for single filing status | (12,000) | |
| Subtotal | 88,000 | |
| QBI deduction ($88,000 X 20%) = | (17,600) | |
| Taxable income | 70,400 | |
| Federal Tax | $ | 11,433 |
If the QBI deduction did not exist this individual's 2018 tax bill would have been $15,416. In this highly simplified example the QBI deduction saved this person $3,983 in federal taxes: a 25.8% tax cut.
There is No QBI Deduction Allowed on Maine Tax Returns
Maine does not allow a QBI deduction. All Maine individual tax returns start with federal adjusted gross income. The federal QBI deduction is claimed AFTER adjusted gross income and, therefore, is not reflected on Maine tax returns.
IRS Notice 2019-07: Key Points
In January of 2019 the IRS issued formal guidance to landlords to assist them in calculating their QBI deduction. This guidance will soon be formalized into an IRS Revenue Procedure. See:
https://www.irs.gov/pub/irs-drop/n-19-07.pdf
Here is a brief summary of key points in IRS Notice 2019-07:
(1) Landlords can treat multiple properties as a single "enterprise" for the purpose of calculating their QBI deduction.
(2) Landlords must distinguish between residential and commercial rentals.
(3) Safe harbor for landlords to rely on to qualify for and calculate their QBI deduction:
(A) Keep good records for each rental enterprise (which could be a group of many properties.) If you have both commercial and residential properties you must keep separate records and accounting reports for each type of property.
(B) Work at least 250 hours per year on rental services such as developing ads to lease properties; negotiating leases; reviewing tenant applications; collecting rent; day to day management and oversight of rental properties; buying supplies for rental properties; and supervising contractors.
(C) For 2018 only landlords can satisfy the 250 hours of rental service requirement through informal documentation. Starting in 2019 onwards, however, all landlords must maintain “contemporaneous” documentation proving that they have indeed performed at least 250 hours of such work per year.
The time log landlords must start maintaining for 2019 and onwards must specifically record the following: hours of work performed; description of work; date; and who did the work. For 2019 tax returns filed in 2020 all landlords must have such contemporaneous time logs.
Failure to maintain these time logs will disqualify landlords from claiming the QBI deduction. Here is another instance of how the tax law turns small clerical matters into big tax consequences. Click here for a time log you can use to document qualifying work:
(4) No triple net leases. Per IRS Notice 2019-07, so-called triple net leases do not qualify for the QBI deduction. The IRS defines triple net leases as any lease where the tenant, not the landlord, pays property taxes, property insurance, and maintenance costs in addition to paying rent.
It may be advantageous for some landlords to revise their leases so they qualify for the new QBI deduction.
(5) Landlords must attach a statement to their tax returns attesting that they have complied with the IRS requirements to claim a QBI deduction (formally known as the “Section 199A” deduction.)
(6) Size Matters - The 250 hours of rental work per year rule means a landlord must work 20.83 hours per month and 4.81 hours per week (on average) to qualify for the QBI deduction. This threshold will disqualify many smaller landlords who only have a few rental units. Landlords will most likely need to own at least 6 - 8 properties to satisfy this rule.
George Adams
Certified Public Accountant Master of Business Administration
Tel: (207) 989-2700 E-Mail: GeorgeAdams@IntelligenceForRent.com
450 South Main Street: The HQ of IQ
Brewer, Maine 04412-2339
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