Have income from rental properties you own? You may be eligible to take a juicy tax break:
The 20% qualified business income deduction., Subject to a litany of rules, self-employed individuals and owners of S corporations, partnerships and LLCs can write off 20% of their qualified business income. QBI is your allocable share of income less deductions from a trade or business. It doesn’t include wages, dividends, capital gain or loss, interest income, etc. Eligible filers take the break on their 1040 return.
Applying the QBI rules to rentals is complicated. The rental activity must generally rise to the level of a trade or business. For this purpose, IRS regs refer to the standard under federal tax code Section 162, the statute that generally governs the deductibility of trade or business expenses. There is no statutory or regulatory definition of a Section 162 trade or business. Instead, this determination is based on a taxpayer’s specific facts and circumstances.
This analysis is somewhat unclear in the context of a realty rental activity, though the QBI regs point out some factors: Type of property (commercial or residential), extent of day-to-day involvement by the lessor or the lessor’s agent, lease terms, number of properties rented out and other ancillary services provided under the lease.
Owners of rental real estate have a safe harbor to mitigate the uncertainty. If met, you can treat the rental as a trade or business for QBI purposes. At least 250 hours must be devoted to the rental activity by the taxpayer, employees or independent contractors in a year. For realty owned four years or more, the 250-hour requirement must be satisfied in three of the five most recent years. Time spent on repairs and maintenance, tenant services, property management,
advertising, collecting rents, negotiating leases and supervising workers counts. Hours put in for arranging financing, constructing long-term capital improvements, and driving to and from the real estate aren’t included in the 250-hour standard. The safe harbor doesn’t apply to property leased under a triple net lease or personally used by the owner for the greater of 14 days or 10% of the days rented. Users of the safe harbor must meet strict recordkeeping requirements.
Contemporaneous records must detail hours, dates and descriptions of the services, and who performed them. If the services are done by contractors or employees, the taxpayer must keep logs of the work done by them, as well as proof of payment. Taxpayers must also attach a statement to their tax return for each year in which they use the safe harbor. See Rev. Proc. 2019-38 for what to include.
Special rules apply to taxpayers who own multiple rental properties. They can treat each property separately or they can aggregate similar rental activities into commercial or residential categories. Commercial real estate can be aggregated only with other commercial realty. Ditto for residential rentals. Mixed-use property, such as a building with residential and commercial tenants, may be treated as a separate rental activity or bifurcated into commercial and residential property.
Think about contributing all or part of your year-end bonus to your 401(k) or another workplace retirement plan if you haven’t yet put in the maximum. The 401(k) contribution limit for 2019 is $19,000 ($25,000 if you’re age 50 or older). Payins are pretax, meaning they’re not hit with federal income tax or payroll taxes. If you want the extra contribution to count for 2019, it must be done by year-end.
Review your retirement plan beneficiaries, if you haven’t done so recently. You can help avoid unintended consequences by updating beneficiary designations of your 401(k) or 403(b) plans, annuities, pensions and IRAs to account for life changes such as marriage, divorce or the death of a spouse or other listed beneficiary. While you’re at it, review the beneficiaries listed in your will and taxable accounts. And if you don’t yet have a will, think about drafting one sooner rather than later.
Check your health flexible spending account. You must clean it out by Dec. 31 if your employer hasn’t implemented the 2½-month grace period or the $500 carryover rule. Otherwise, you will forfeit any money left in your account.
Eligibility for HSAs is restricted. You must have a high-deductible health plan to qualify. The minimum allowable deductible for 2020 is $2,800 for family coverage and $1,400 for self-only coverage. And out-of-pocket costs, including copayments, can’t exceed $6,900 a year for individual coverage and $13,800 for family coverage. Expenses for preventive care can be covered dollar for dollar by HDHPs, even if the deductible hasn’t been met. Alternatively, preventive medical costs can be covered by a lower deductible, depending on the terms of the insurance policy. This past summer, IRS relaxed the rules for people with certain chronic illnesses. Some services and drugs for a range of chronic conditions are treated as preventive care that can be covered by HDHPs, including blood pressure monitors for hypertension,
statins for heart disease, and selective serotonin reuptake inhibitors for depression.
People enrolled in Medicare can’t contribute to HSAs. But don’t despair if you have a balance in an existing HSA. Once you turn 65, you can use HSA money on a tax-free basis to pay monthly Medicare premiums. And while you’re on Medicare, you can continue to take tax-free payouts from your HSA for out-of-pocket medicals. HSAs have several major federal tax advantages that owners can enjoy. Contributions to HSAs are deductible or are from pretax wages, up to a limit.
For 2020, the annual cap on contributions to HSAs is $3,550 for self-only coverage and $7,100 for family coverage. People born before 1966 can put in $1,000 more. Excess payins aren’t deductible and are hit with a 6% yearly excise tax until withdrawn. Earnings inside an HSA build up tax-free for the account owner. HSAs don’t have a use-it-or-lose-it rule, unlike health flexible spending accounts. And any withdrawals that are used to pay medical expenses are not taxed.
Distributions from HSAs for other purposes are taxed and subject to a 20% penalty.
The fine doesn’t apply to account owners who are age 65 or older, disabled or deceased.