Changes For Owners of Rental Real Estate
The biggest (and most complicated) change of the Tax Cuts and Jobs Act of 2017 (TCJA) is the 20% pass-through deduction provided for by IRC Section 199A. This allows individual business owners to deduct 20% of their business net income in calculating their federal income tax. But of course there are many limitations involved, starting with what types of businesses are allowed to take the deduction, in particular, is it available to landlords? The IRS recently released Revenue Procedure 2019-7 which provides some guidelines to determine when a rental activity rises to the level of being a trade or business. The Rev. Proc. provides for a "safe harbor" set of circumstances that, if met, will not be challenged:
Maintain separate books and records for each rental activity (or combined enterprise if grouped together)
Perform 250 hours or more of "rental services" per year, and
Maintain contemporaneous records regarding a) hours of services performed, b) description of all services performed, c) dates on which the services were performed, and d) who performed the services.
The IRS has set the bar very high to meet the safe harbor, but not meeting it does not mean automatic disqualification. It does, however, place the burden on the taxpayer to have sufficient convincing evidence that the rental is substantially more that a passive activity. In general, a single residential rental house or a commercial building with a triple-net lease will not qualify while a multi-unit apartment building might. It will depend on the facts and circumstances of the specific situation.
There is one exception identified in the regulations which allows the 199A deduction for rentals to a "commonly controlled" trade or business owned by the taxpayer. The property must be rented to an individual or pass-through (no C corporation) and the same owner or group must own 50% or more of both the property and the business.
One more thing, a trade-or-business is required to issue a Form 1099 to report payments for services, be sure to comply with those rules if you are claiming the 199A deduction.
Deducting Mortgage Interest
The TCJA has created another set of limitations for homeowners with mortgage interest. The term Home Acquisition Debt (HAD) is a debt secured by your primary or second home that was used to buy, build or substantially improve that home and was taken out after October 13, 1987. You can no longer deduct the interest on a loan that was used for a purpose other than to buy, build, or substantially improve the home that is security for the loan.
If you took out the mortgage on or before October 13, 1987, it is "grandfathered debt" and fully deductible. If you took out the HAD between October 13, 1987 and December 16, 2017, you can deduct the interest on debt up to $1 million ($500,000 if married filing separately). Interest on HAD taken out after December 15, 2017 is limited to debt up to $750,000 ($375,000 if married filing separately). The dollar limits apply to the combined mortgages on your main and second home.
A qualified home includes stock in a cooperative housing corporation owned by the tenant-stockholder.
If you used the proceeds of an equity loan for investment or business purposes, the interest may still be deductible, but the borrowing needs to be traceable to the activity it was used for.
Any interest accrued on a reverse mortgage is considered home equity debt and isn't deductible.
For more details see IRS Publication 936.
A word of caution: this is a very brief summary and does not include all of the details that may impact your individual situation. Please contact us if you would like more information.
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