Real Estate News & Commentary

Tax Reform Update: A New Way to Reduce Taxes on Rental Income

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taxes, rental property, real estate investor, rental income

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Even though the government was shut down, it looks like the IRS was still hard at work.

We are excited to let you know that there are some new details that the IRS recently released, which may be of benefit to real estate investors. Some of the most impactful pieces of new information released by the IRS were details on how rental income may qualify for the Section 199A tax benefit.

What is the Benefit?

In short, the new Section 199A benefit that came into effect for 2018 means that certain types of income may receive tax-free treatment on the first 20% of taxable profit. For example, if you are a landlord with taxable rental income of $100, the first $20 of that may be completely tax free and you only pay taxes on the remaining $80.

Who Does This Benefit?

For real estate related activities, we have always known that this benefit was available to realtors, real estate brokers, flippers, and real estate developers. Last week, the IRS finally released information to confirm that certain rental income may also be eligible for this tax break.

landlord, rental, homeowner, realtor

What’s New?

The recent IRS regulations provided “safe harbor” rules to define the criteria that could allow a taxpayer’s rental income to receive this 20% tax-free treatment. Safe harbor simply means that if the taxpayer meets these rules, their rental income should be eligible for the Section 199A benefit calculation. To qualify for the safe harbor rules, the taxpayer must meet all four of the following requirements:

  • Have separate books and records for the rental real estate activities
  • Have over 250 hours of rental service activities
  • Have contemporaneous records to document these hours and services
  • Attach a signed statement to the tax return to indicate the safe harbor requirement has been met

Related: PSA: Taxes Are the Biggest Cashflow Killer (With Examples)

The 250 hours of rental service activities may be aggregated amongst your eligible properties so that you may not need to meet the hours requirement for every single rental property separately. Eligible services include time spent on maintenance, repairs, rent collection, payment of expenses, and activities in order to rent the property.

The IRS also indicated that the eligible services do not need to be performed only by you as the property owner and can include services performed by employees, agents, and independent contractors, as well.

apartment building, real estate investment

The other good news is that eligibility for the 20% tax-free rental income benefit is not connected in any way to real estate professional status. So, even if you are someone who does not qualify as a real estate professional, you may still be able to receive this tax benefit.

Even if you are a passive investor in an apartment syndication, your allocated rental income may be eligible for this tax benefit. This should prove to be a great tax savings tool for BRRRR investors and those operating in the high cash-flowing, short-term rental space.

It is important to keep in mind that just because the safe harbor rules are not met, it does not automatically mean the tax benefit is not applicable to rental income. There may be other ways to demonstrate eligibility outside of these safe harbor rules, as well.

It was not all good news, however. In the latest IRS-issued guidelines, it was indicated that triple net rental real estate and a rental property also utilized by the taxpayer as a residence during the year would not be eligible for this tax benefit. House hackers: this may be a tax benefit you will have to miss out on.

Related: IRS Code Section 199A: How the New 20% Pass-Through Deduction Affects Investors

What Does This Mean?

So, what does all this mean and does it impact you in any way? Well, the answer is, “It depends!”

The good news is that these new rules should not increase your tax liability in any way.

If you have net taxable rental income after expenses and depreciation, it is very likely that these new regulations will allow you to pay less taxes on the rental income.

Alternatively, if you are like most investors and expect to have a net rental tax loss after deducting expenses and depreciation, then this new benefit would likely not impact your tax bill for the year since there is no taxable rental income.

As you can see, these latest IRS regulations are designed to help reduce taxes for rental property owners. Make sure to work with your advisors this tax season to reduce your tax bill and keep more money to invest and grow.

Does this make sense to you? Will you benefit from this change?

Leave a comment below.

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Amanda is a CPA specializing in tax strategies for real estate, self-directed investing, and individual tax planning with over 18 years’ experience. She is also a real estate investor of over 10 years with a focus on long-term hold residential and multi-family assets across multiple states. Formerly a tax advisor at the prestigious accounting firm Deloitte in the Lead Tax Group, focusing on tax strategies for the real estate industry and high net worth individuals, and at an international Fortune 500 Company in the high-tech industry in the Corporate Tax department, Amanda’s goal is to help investors with strategies designed to supercharge their wealth building. Amanda’s highly rated book Tax Strategies for the Savvy Real Estate Investor is amongst Amazon’s best seller list. A frequent contributor, speaker, and educator to some of the nation’s top investment and self-directed IRA companies, Amanda has been featured in prominent publications including Money Magazine, Realtor.com, and AllBusiness.com. Amanda was a speaker at Talks at Google and is a 40 under 40 honoree by CPA Practice Advisor, showcased amongst the best and brightest talent in the accounting profession. Her firm Keystone CPA, Inc. was awarded a two-time winner of the Top CPA of Orange County Award by OC Metro Magazine. She is certified by the CA State Board of Accountancy and is a member of the prestigious American Institute of Certified Public Accountants (AICPA) with clients across the nation.

    Christopher Smith Investor from brentwood, california
    Replied 6 months ago
    Do supportive services (e.g., accounting and tax) as long as they are directly supportive of operational activities, and not investment or financing related activities qualify as hours for meeting the 250 hour threshold.
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thanks for your comment Christopher. The items that do not qualify include:Arranging financing;Procuring property; Studying reports on operations; Planning, managing, or construction of long-term capital improvements; or Hours spent traveling to and from the real estate.
    Edward Synicky Rental Property Investor from Yorba Linda, CA
    Replied 6 months ago
    As part of my real estate business I have rentals as well as rel estate notes. Do my note income qualify?
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Interest income currently does not qualify for 199A. If your note income was active income and not interest then it might.
    Edward Synicky Rental Property Investor from Yorba Linda, CA
    Replied 6 months ago
    can you define “active income” I sold a rental home and carried back a first TD, is that active income?
    Edward Synicky Rental Property Investor from Yorba Linda, CA
    Replied 6 months ago
    can you define “active income” I sold a rental home and carried back a first TD, is that active income?
    Sam Liang
    Replied 6 months ago
    Is the 20% deduction before or after itemized/standard deduction and depreciation?
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    The 20% is applied to the qualified business income (for example rental income Sch E or sole prop income Sch C) and not part of itemized/standard deductions although those are part of the threshold calculation in some instances. Thanks for your question Sam.
    Sam Liang
    Replied 6 months ago
    Thanks for the reply, Amanda! So my understanding is that QBI is just the total rental income, before deductions are subtracted, correct? Reply Report comment
    Sam Liang
    Replied 6 months ago
    Thanks for the reply, Amanda! So my understanding is that QBI is just the total rental income, before deductions are subtracted, correct?
    Sam Liang
    Replied 6 months ago
    Thanks for the reply, Amanda! So my understanding is that QBI is just the total rental income, before deductions are subtracted, correct?
    Dmitriy Fomichenko Solo 401k Expert from Anaheim Hills, CA
    Replied 6 months ago
    Thanks for the article, Amanda, great info!
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thanks for reading Dmitriy!
    Eric Carr Real Estate Broker from Los Angeles, CA
    Replied 6 months ago
    I see, if there is a tax loss, this doesn’t apply – very interesting stuff
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Correct….no benefit if you already have a net tax loss. Thanks for reading Eric!
    Paul Leason Realtor from Grand Rapids, MI
    Replied 6 months ago
    Another interesting and informative article you have shared Amanda. Much appreciated.
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thanks for reading Paul!
    Cory Binsfield Financial Advisor from Duluth, Minnesota
    Replied 6 months ago
    Thanks for the update Amanda! I’ve been following the 199a info ever since it was first proposed and I’m glad the IRS finally issued some clarification. Looking forward to more deductions on my buy and hold portfolio in addition to the real estate professional designation and depreciation. The bonus depreciation is another game changer as well.
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thanks for reading and commenting Cory!
    Eddie Trumble Rental Property Investor from Peachtree Corners, GA
    Replied 6 months ago
    Thanks for the update.
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thank you for reading Eddie!
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thank you for reading Eddie! Reply Report comment
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thank you for reading Eddie!
    Sean Cullen Rental Property Investor from Warner Robins, GA
    Replied 6 months ago
    Great post! Thank you for sharing Amanda.
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thank you Sean!
    Jim Rosengarth
    Replied 6 months ago
    Will this apply to vacation rentals where you spend less than the maximum allowed days in it (14) per year?
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thanks for your question Jim. For a property that is rented out less than 14 days a year you generally do not need to report the rental income. Thanks for reading! Reply Report comment
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Thanks for your question Jim. For a property that is rented out less than 14 days a year you generally do not need to report the rental income. Thanks for reading!
    Michael Baum from Olympia, Washington
    Replied 6 months ago
    Hey Amanda! Just to clarify Jim’s question, I think he means where they owner spends less than 14 days using the home rather than renting it less than 14 days. I have the same question of vacation rentals meet the same requirements as long term rentals. Thanks for the great article! I am hoping that this will work for us!
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Hi Michael: The IRS has not referenced that if it is used by the owner for less than 14 days it would qualify. It actually states: Property used as a residence by the taxpayer for ANY part of the year would disqualify. Hope this helps. Reply Report comment
    Amanda Han Accountant from Fullerton, CA
    Replied 6 months ago
    Hi Michael: The IRS has not referenced that if it is used by the owner for less than 14 days it would qualify. It actually states: Property used as a residence by the taxpayer for ANY part of the year would disqualify. Hope this helps.
    Michael Baum from Olympia, Washington
    Replied 6 months ago
    Well, that is a bummer. The IRS allows owners to use their vacation properties for up to 14 days. Anything above that disqualifies for any tax deductions. So even if the property is being used as a vacation rental and is noted as such it is still disqualified? Seems like an unfortunate thing.
    Michael Baum from Olympia, Washington
    Replied 6 months ago
    Ok, so I searched around on various CPA blogs etc and they agree with you 100% : Vacation rentals are not eligible for safe harbor. Real estate used as a residence by the taxpayer for any portion of the taxable year is not eligible for the safe harbor rules. It is what it is. I would assume that if you never stayed there at all, it would qualify. I wonder if staying there for maintenance purposes (which do not count towards the 14 days), would be the same. Thanks a bunch for the article and the quick response! I didn’t make the 250 hour cut anyways due to having only one rental so I don’t qualify regardless.
    Carole Comegys
    Replied 6 months ago
    Hi Amanda, I’m brand new to Real Estate Investment and am focused on getting a solid foundation through educating myself and becoming engaged with all of you at Bigger Pockets. The resources available are amazing! Your blog is my first and it’s been great, I wasn’t even sure what a blog was, but I’m learning. Thanks Amanda
    Amanda Han Accountant from Fullerton, CA
    Replied 5 months ago
    Thanks for reading Carole!
    Dave Rav from Summerville, SC
    Replied 5 months ago
    Thanks for the tips! Good job breaking it down, and better yet SUMMARIZING. Question: do we get credit toward Sect 199A (or any other tax rules) for prospecting, due diligence, informal inspection, or searching for properties? I know many of us spend a lot of time looking at properties we don’t own (yet). For example, often you may look at 10 properties and buy 1 or 2. Thats a lot of time, mileage, and resources utlilized. Care to comment here? Thanks!
    Amanda Han Accountant from Fullerton, CA
    Replied 5 months ago
    Currently time spent on travel and procurement of the property are not considered eligible time for the safe Harbor rule unfortunately. Thanks for reading Dave!
    Amanda Han Accountant from Fullerton, CA
    Replied 5 months ago
    Currently time spent on travel and procurement of the property are not considered eligible time for the safe Harbor rule unfortunately. Thanks for reading Dave!
    Steve Kresse from Twinsburg, Ohio
    Replied 5 months ago
    Very good read. Thanks for the info. I have a question. I spend a couple months rehabbing my rentals prior to putting them in service. I do the work myself. Would this work count toward the 250 hours?