When Rental Real Estate Qualifies as a Business

Cartoon picture of someone holding a white sign with dollars and coins.

The Tax Cuts and Jobs Act (TCJA) was signed and enacted in December 2017. In September 2019, almost two years later, the IRS issued final guidelines about whether taxpayers who rent real estate qualify for a new deduction under TCJA, the Qualified Business Income Deduction, aka “Code Section 199A”.  Section 199A allows business owners to deduct 20% of net business income on her or his individual income tax return. 

This new deduction is a very attractive tax benefit for eligible taxpayers. Who is eligible? TCJA extended the benefit to the owners of rental real estate but did not make clear what properties qualify and how to substantiate rental activities. Taxpayers and tax professionals had to use their best judgement to file 2018 income tax returns. Good news – guidance released last month clarifies when rental real estate is treated as a trade or business and how to substantiate the 199A deduction.

The September 2019 IRS guidelines state that rental real estate will be treated as a trade or business if the following requirements are satisfied during the tax year:

  • Maintain separate books and records of income and expenses for each rental property. You’ve already been doing that all along, right?
  • Perform 250 or more hours of rental services on rental activities. Good news – taxpayers with more than one rental property combine all activities to meet the 250 hours (i.e., the hours requirement is NOT per property).  Activities include advertising to rent the real estate; negotiating and executing leases; and management, operation, maintenance, and repair of the property, even services performed by a contractor or employee.
  • Maintain contemporaneous records, including time reports, logs, or similar documentation of the description and hours of all services performed; dates when such services were performed; and who performed the services (i.e., a contractor). Records could be requested by the IRS to substantiate rental activities.

As usual, the IRS guidelines address exclusions from Section 199A eligibility, including:

  1. Travel to and from the rental property does not count towards the 250 hours of rental services. 
  2. Real estate used by the taxpayer as a residence for any part of the year is not eligible.
  3. Real estate rented under a triple net lease is also not eligible, although the activity may qualify as a trade or business, depending on the owner’s business activities. 

There’s more! Starting with 2019 individual income tax returns, taxpayers with activities that qualify for the Section 199A deduction must include a statement indicating that the 199A deduction is being claimed using a new form, Form 8995, Qualified Business Income Deduction

Want more details? The IRS website has them here https://www.irs.gov/newsroom/irs-finalizes-safe-harbor-to-allow-rental-real-estate-to-qualify-as-a-business-for-qualified-business-income-deduction

Will Your Wishes be Granted?

You’ve spent years planning for your financial future, accumulating assets. If the unexpected were to happen, would your assets be given to the people that you want to get them? Will your wishes be granted? 

Estate planning is a complicated topic that should be addressed by an attorney. However, one simple and important estate planning action you can take immediately is to designate a beneficiary for your financial assets. If you’ve already named beneficiaries to inherit your assets, check them periodically to make sure that they reflect current reality.

Financial assets to name and check on beneficiary designations include: 

  • Bank accounts
  • Brokerage accounts
  • Retirement accounts
  • Company benefit plans
  • Life insurance policies
  • Annuities
  • 529 College savings accounts

Sure, we all think that we have plenty of time to designate beneficiaries and make sure our wishes are followed. But putting it off can lead to unforeseen and undesirable consequences. If you need motivation, here’s a real-life horror story to light a fire under you.

“Dad” failed to change the beneficiary designations for his pension benefits and life insurance after his divorce, so Dad’s former wife was still the named beneficiary. Two months later, Dad died in a car crash. The Court ruled that the beneficiary designations overruled a state law that would have automatically disinherited the ex-wife. So, the ex-wife received the money, and the kids were handed the bills for an unsuccessful legal fight.

Divorce is not the only situation where failing to turn in or update beneficiary designation forms can cause heartache for your intended heirs—it’s just the most obvious situation. You get the idea. When things in your life change, you may need to refresh your beneficiary designations.

Other tips:

  1. Probate – Another big reason to designate beneficiaries: it avoids probate. Also, consider naming contingent beneficiaries. These are individuals who stand in line behind your primary beneficiaries. 
  2. Living Trusts and WillsAs a general rule, whoever is named on the most recent beneficiary form will get the money automatically when you die—regardless of what other documents might say.      
  3. Check – Review your designations at least once a year or whenever significant life events occur. It usually takes only a few minutes to conduct a checkup and make any needed changes. Often you can access the necessary forms online. 

Don’t wait if you want your wishes to be granted.

Extended Tax Returns Due October 15

Way back in April when you got an extension to file your 2018 income tax returns, you breathed a sigh of relief. Phew! Six additional months to file. Seemed like all the time in the world. Well, “all the time in the world” had passed and you are up against another deadline to file – by next Tuesday. No more extensions and no more excuses.

Two tips about filing extended income tax returns:

File by October 15th

It’s really down to the wire now. No additional filing extensions are available after October 15th. The mad scramble is on to get replacement copies of missing wage statements, organize your business expenses and scan your bank account statement for charitable contributions. If you really cannot get your business expense information organized as thoroughly as you should, use your best estimates and file a return by the due date. Then, finish getting those documents together and file an amended return. Failure-to-file penalties are expensive.

If You Still Owe

Even if you paid with your extension request, you could still end up owing more. If that’s the case, pay as much as possible with your return to reduce interest and penalties. Keep in mind that interest accrues daily on unpaid tax balances. It’s free to use IRS Direct Pay to securely pay from your checking or savings accounts. Can’t pay it all now? The IRS offers payment plan options, allowing you to pay over time. Details about all of these options (and their costs) are all found at the Paying Your Taxes page on IRS.gov.

Filing an extension in April feels terrific, until that six-month reprieve flies by and you there you are. Confronted with another deadline. Less than a week to go. No more excuses. Go ahead and get started. Maybe it won’t be as painful as you imagine. Need help meeting the October 15th tax filing deadline? Go to the IRS website at https://www.irs.gov/newsroom/the-filing-deadline-for-extension-filers-is-almost-here. Need more guidance? Consult a qualified tax professional.