Taxes: No one likes to talk or think about them. Unfortunately, as a landlord, taxes are an unavoidable part of running your rental business.
But there is a good reason to care about taxes: tax deductions. Understanding how to qualify for and apply deductions can save you hundreds on your taxes each year. That’s a good reason to stay in-the-know about the current tax policies.
Rental property tax policies have recently undergone several changes. Some were due to the COVID-19 pandemic, while others resulted from the 2018 Tax Cuts and Jobs Act (TCJA)—a key tax law all landlords should be familiar with.
So, what should landlords know about the TCJA?
Here are three critical Tax Cuts and Jobs Act benefits that all landlords should know.
Lower Individual Tax Rates
The first effect of the TCJA was that it decreased individual tax rates.
Before the TCJA came into effect, individual income between $37,951 and $91,900 was taxed at 25%. Now, that same income bracket (shifted slightly to $38,701-$82,500) is only taxed at 22%.
As this comparison demonstrates, the TCJA likely lowered your income taxes this year.
Additionally, the TCJA tax brackets will not expire until after 2025, so these changes will remain as is for the next several years.
Individual income taxes are not directly related to your rental business, but they do contribute to the overall financial picture. Many small to mid-sized landlords keep their day jobs while investing in real estate, which makes lower income tax rates are still something to celebrate. This change is especially welcome for landlords juggling multiple financial responsibilities.
Qualified Business Income Deduction
Another change initiated by the TCJA was the qualified business income deduction (QBID). The QBID, also known as the pass-through deduction, allows you to deduct up to 20% of your net rental income from your income taxes.
To qualify for this deduction, you must meet three criteria.
First, your rental activities must be classified as a business—not a passive investment or not-for-profit activity. This requirement refers to the three landlord classifications: passive investor, business owner, and not-for-profit organization owner. If you aren’t already, your goal is to be considered a business owner, as this classification will give you access to the most rental deductions (including real estate loss deductions, home office deductions, and start-up expenses).
The business-owner designation usually isn’t difficult to achieve if you are actively managing your properties and make a profit. If you think the IRS might scrutinize you, be sure to keep good records, demonstrate regular attention to your rentals, and always rent your units out at market-rates or above.
The second requirement for the QBID is the pass-through requirement: your profits and losses must go through the business. Thirdly, you must have qualified business income, or QBI, which you can achieve by actively collecting rental payments.
Using the QBID is one of the best strategies of maximizing your deductions and credits in your rental business. It is recorded and deducted on Schedule E, with most other landlord business deductions.
Section 179 Expensing Limit Increase
Section 179 expensing is another one of the best rental property tax write-offs landlords can claim. The section 179 expense limit was increased due to the TCJA.
Section 179 expensing allows you to deduct the cost of certain personal property you use in your business, such as equipment, computers, or furniture.
Before the TCJA, the expense limit for these items was $500,000. Now, the limit is up to $1,000,000. This gives you a considerable margin to purchase items for your rental units and deduct them as you would any other operating expense. The increased spending limit is available for property you bought and put into service from September 27, 2017, to December 31, 2022.
Additionally, landlords are now free to apply this deduction to personal property used in residential units, which was not possible before the TCJA.
Conclusion
As a landlord, your goal should be to understand rental property taxes for what they are: not just an additional stress, but an opportunity to save money and pay less taxes. The Tax Cuts and Jobs Act is one way that the IRS has favored landlords in the past few years. By taking advantage of these three TCJA benefits, you can leverage your tax knowledge to achieve the best deductions for your rental business.
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