Congress enacted a major tax reform law in 2017, which took full effect in 2018. Under the Tax Cuts and Jobs Act (TCJA), landlords can save on taxes. For example, the TCJA introduced a new tax deduction for owners of pass-through businesses. The new tax deduction makes landlords eligible to deduct an amount equal to 20% of their net rental income. Their rental income consists of the payments they receive for the use of occupation of their properties.
The rental activity must be a business
A landlord can only make use of the pass-through deduction if a rental activity qualifies as a business for tax purposes. Rentals that aren’t with the aim of making a profit do not fall into the category. Landlords must do business regularly and continuously with the purpose of making a profit. A rental business is automatically deemed to be a business that qualifies for a pass-through deduction if landlords do the following:
- They must keep separate records showing income and expenses.
- They must perform 250 hours of real estate services every year.
- They need to keep records of the services they perform.
Taxes can be intimidating for first-time and even seasoned landlords. If they own Colorado Springs rental properties, it can be very helpful to use the services of a property management company like Evernest, Mynd or APM. One of the major benefits is that when it comes to doing taxes, the information provided to landlords by property managers can be invaluable. They keep meticulous records, including rental income, expenditure on maintenance and on all the other services they perform. Landlords will have all the documents they need at hand when filing tax returns.
It’s essential for landlords to take advantage of deductions. Learning what they are able to deduct can help them to increase their tax savings. There are many deductions landlords are eligible for, such as mortgage interest, insurance premiums, maintenance and repairs, advertising costs and utilities. Consistent with the law prior to TCJA, landlords can still write off all the standard operating expenses for rental properties.
The 20% pass-through deduction
Many landlords own rental properties as sole proprietors or through limited liability companies (LLCs) or partnerships. These business entities pass through profit from rental activity to the owner or owners’ individual tax returns. Property owners pay tax on rental income at their individual income tax rates. If landlords qualify they can take a 20% pass-through deduction. This deduction is in addition to any other deductions. If landlords qualify for it, they are effectively only taxed on 80% of their rental income. For example, if George is a landlord who earns a total profit of $20,000 as a sole proprietor, he adds it to his other income and pays tax on it at individual tax rates.
Taxable income below $170,050 for singles and $340,100 for married couples
Landlords qualify for the income tax deduction of 20% on rental income only if their taxable income for the year from all sources after deductions is less than $170,050 if they’re single or $340,100 if they are married and file jointly. Say George had $150,000 in taxable income in 2022. As a sole proprietor, he could take a pass-through income deduction of 20% on $20,000 of his rental income, which equals $4,000. This would save $960 in income tax.
If income levels are above the levels mentioned, landlords can still take a pass-through deduction, but the deduction is limited by various requirements.
100% bonus depreciation
Business owners could deduct in a single year up to 50% of the cost of personal property they purchase for their business purposes. The TCJA increased the amount to 100% for property business owners to acquire and put into service. Landlords can fully deduct the costs of personal property they use in a rental capacity, such as appliances, furniture, laundry equipment and gardening equipment. This bonus depreciation amount is to be phased down to 80% in 2023 and again by another 20% each subsequent year.
Lower individual tax rates
Most residential landlords pay income tax on rental profits at individual tax rates. The TCJA reduced individual tax rates. Standard deductions nearly doubled but personal exemptions were eliminated. For example, prior to TCJA, individual taxable income between $37,951and $91,900 was taxed at a rate of 25%. Afterward, individual taxable income between $38,701 and $82,500 is taxed at a rate of 22%.
The TCJA made some substantial changes in the taxation of real estate, especially for investors. Two hurdles landlords have to face to qualify for the pass-through deduction is to meet the definition of a qualified business and to fit under the individual income requirement. Tax advisers can help landlords to take full advantage of the benefits given by the TCJA.