20% pass through deduction for 2018

14 Replies

I own an insurance agency and over the last 13 months I have bought, rehabbed, and rented 5 SFR’s... I actively manage the properties and I run them like a business. I meet/screen prospective tenants, I cut grass, paint, hire contractors, monitor and pay all bills, and I’m working on designing a website for my rental business. Why am I being told I don’t qualify for the 20% pass thru deduction since buy and hold rentals are considered passive investments? I put in more than 750 hours managing this side business?
Originally posted by @Brian S. :
I own an insurance agency and over the last 13 months I have bought, rehabbed, and rented 5 SFR’s... I actively manage the properties and I run them like a business. I meet/screen prospective tenants, I cut grass, paint, hire contractors, monitor and pay all bills, and I’m working on designing a website for my rental business. Why am I being told I don’t qualify for the 20% pass thru deduction since buy and hold rentals are considered passive investments? I put in more than 750 hours managing this side business?

If you do a search on here there have been several discussions on the topic. 

Typically real estate is passive and the IRS didn't issue guidance specific to rentals with regard to the new 20% passthrough , nor does it plan to. 

What it comes down to is whether your real estate rentals meet the  level of a business per IRC 162. This is very open to interpretation and comes down to making an educated determination based on prior tax cases and interpretations- since the IRS didn't clearly lay it out. And how closely your business mimics the requirements of IRC 162 and can be backed by earlier tax court rulings. 

If your tax person hasn't dug deep enough into this new issue to come to this conclusion they  may not be specialized in real estate. 

@Brian S. The 750 hours cited deals with qualifying as a 'real estate professional' under IRC Sec 469.  If you have a full time job at your insurance agency it may be hard to meet that qualification even if you dedicate more than 750 hours to real estate activities.  IRC 469 deals with passive activity loss rules and doesn't relate to the 'trade or business' question at hand here.

Although your individual facts and circumstances must be considered, there's volumes of case law that show the tax court generally (but not absolutely) regards even a single piece of rental real estate as a trade or business.  Hazard v. Commissioner, Elek v. Commissioner, and Lagreide v. Commissioner come to mind.

As @Natalie Kolodij mentioned, perhaps a second opinion is healthy every now and then.

You should discuss with your tax counsel. I'd be leaning towards your description as qualifying as a trade or business under section 162. The number of hours is irrelevant; you don't have to be meet the real-estate professional test for a section 162 analysis.

The new 20% deduction is for Opportunity Zoned areas only. For example cities like Detroit are categorized as Opportunity Zones, You need to check with your state to identify those areas that qualify.

If you have been told you do not qualify it probably means you are working in an area that is not categorized as an, "Opportunity Zone".

First you have to earn money, pay taxes on that money, then use the balance to reinvest in an Opportunity Zone, and the money you earn on those Opportunity Zone located  projects will be tax free for up to 10 years, no telling what will be the result of that program after the 10 years are up, probably be discontinued in my opinion. 

Me I am moving my entire operation to Puerto Rico because like Detorit all of Puerto Rico is an Opportunity zone so if you operate out of Puerto Rico then your money is earned in Puerto Rico by investing in a company located there but your investments can really be anywhere. It all depends on where you are managing and operating out of . I invest in a Puerto Rico Company and pay a far reduced tax there like 4% but I invest in an LLC there with a management that make the investment decision and they can chose to invest in a New York Property. The LLC pays taxes of 4% and I personally pay taxes of something like 7%. However since this is a legal matter you would do best to consult with a knowledgeable attorney. I have not made the move but so far this is what on attorney has told me. I will need to verify it of course, could be its all wrong . Its a new law and policy so I am sure much is yet to come out of correctly interpreting the new tax law.

Hi @Brian S.

The Section 162 trade or business test, even though it is based on facts and circumstances, means your rental activities likely qualify for the Section 199A tax deduction as long as you have regular and continuous involvement with them.

Originally posted by @Gilbert Dominguez :

The new 20% deduction is for Opportunity Zoned areas only. For example cities like Detroit are categorized as Opportunity Zones, You need to check with your state to identify those areas that qualify.

If you have been told you do not qualify it probably means you are working in an area that is not categorized as an, "Opportunity Zone".

First you have to earn money, pay taxes on that money, then use the balance to reinvest in an Opportunity Zone, and the money you earn on those Opportunity Zone located  projects will be tax free for up to 10 years, no telling what will be the result of that program after the 10 years are up, probably be discontinued in my opinion. 

Me I am moving my entire operation to Puerto Rico because like Detorit all of Puerto Rico is an Opportunity zone so if you operate out of Puerto Rico then your money is earned in Puerto Rico by investing in a company located there but your investments can really be anywhere. It all depends on where you are managing and operating out of . I invest in a Puerto Rico Company and pay a far reduced tax there like 4% but I invest in an LLC there with a management that make the investment decision and they can chose to invest in a New York Property. The LLC pays taxes of 4% and I personally pay taxes of something like 7%. However since this is a legal matter you would do best to consult with a knowledgeable attorney. I have not made the move but so far this is what on attorney has told me. I will need to verify it of course, could be its all wrong . Its a new law and policy so I am sure much is yet to come out of correctly interpreting the new tax law.

QOZ are a totally different program than the 20% passthrough. 

ok, then is it safe to assume if you are a full time real estate investor you would qualify for the 199A. In other words if I am a dentist and work a good many hours as a dentist but also invest and manage real estate I would probably not qualify for the 199A?

So the criterisa then is based on how much time you devote to being a real estate investor?

In other words in order to qualify you have to show is is your main or only profession?

You should be fine under the IRS proposed regulations of a Safe Harbor if Rental Services exceed 250 hours per year. Issue I have with this is that depending on how much maintenance my rentals needs I have varying amounts of Rental Services in a given year. Some years way over 250 and some years where I have little turnover perhaps less. The proposed regulations do still allow for claiming the deduction even if you don't meet the Safe Harbor minimum if you qualify under § 1.199A-1(b)(14). IRS Notice 2019-07