Posts Tagged ‘rentals’

Final 199A Regulations

The Section 199A deduction requires you to be a trade or business. Follow these rules to take advantage of this generous deduction on your rental properties.

The Section 199A deduction requires you to be a trade or business. Follow these rules to take advantage of this generous deduction on your rental properties.

The IRS released final regulations on 199A. The Kiplinger Tax Letter said it best: “Final regulations provide limited guidance, but IRS gives a safe harbor.”

In this post we will discuss the safe harbor as it relates to “trade or business” with special emphasis on application with rental properties. The safe harbor doesn’t apply to all taxpayers and the trade or business designation is still possible without meeting the safe harbor parameters.

The final regulations run 248 pages. I will follow this post with a detailed post on 199A tiers with several decision trees. Due to the length and complexity of the regulations we are forced to remain focused on one aspect of 199A. Taxpayers with a sole proprietorship, partnership, S corporation or investment property may wish to seek the services of a competent tax professional until more clarification is reached through more regulations or from the Tax Court.

Links are provided at the end of this post to the entire 248 pages of regulations released and Notice 2019-07 (only 10 pages!) dealing with the trade or business safe harbor for real estate issues for your further research.

 

Remaining Problems with the Final Regulations

The final regulations refer to Section 162 (as previous releases have). Section 162 generally governs the deductibility of expenses for a trade or business. But Section 162 is unclear when it comes to rental activities. 

The reason for the vagueness is because the facts and circumstances of each taxpayer differs. Whether the property is commercial or residential, the lease terms, services provided, how many properties owned  and day-to-day involvement in the activity all play a role. We will touch on each of these throughout this post. 

The biggest problem with the final regs is that they were issued after 2018 was in the books. Nobody knew they needed to keep track of time spent in the activity, nor did they know they were required to keep a separate bank account for the rental activity.

The IRS, aware of this, has granted some leeway for the 2018 tax return as it regards contemporaneous records.  However, for tax years beginning after December 31, 2018 you must follow the new regs for record keeping. Ignorance is not an excuse.

Once the IRS laid out the safe harbor for a “rental real estate enterprise” they state: 

Failure to satisfy the requirements of this safe harbor does not preclude a taxpayer from otherwise establishing that a rental real estate enterprise is a trade or business for purposes of
section 199A.

This means the safe harbor isn’t the only way to take advantage of the generous 199A deduction. 

If you use the safe harbor you must include a statement to that effect with the tax return. Qualified pass-through entities (RPEs) can also use the safe harbor and provide the taxpayer with the required statement that application of the safe harbor was used as outlined by regulations. This is attached to your return.

 

Safe Harbor

The new deduction for rental property owners is no game. Get your deduction today.Rental Real Estate Enterprise: For purposes of the safe harbor the IRS uses the term rental real estate enterprise, defined as an interest in real property held for the production of rents and may consist of an interest in multiple properties. 

The individual or pass-through entity relying on this safe harbor must hold the interest directly or through a disregarded entity. This means you can only use the safe harbor if you hold the property personally or as an LLC treated as a disregarded entity. If you hold the property in an LLC electing to be treated as an S corporation (and there is no reason to ever hold real estate in an S corp) you cannot use the safe harbor.

The taxpayer must treat the property (or group of properties) held for the production of rents as a separate enterprise. This means you hold each property or group of properties as a single enterprise. Which means you have a separate bank account and name for the enterprise. Those with multiple LLCs could experience issues with qualifying for the safe harbor. 

Commercial and residential property cannot be part of the same enterprise. Yes, this can cause real confusion when you have mixed property under one LLC and/or business name. As I read this regulation you would need to qualify for the safe harbor for both the residential and commercial property.

Once you establish a treatment for your properties (which properties belong with each enterprise) you must continue with the same treatment unless there has been a significant change to the facts and circumstances (sale or purchase of property, for example).

Safe Harbor Defined: For the Qualified Business Income Deduction only, a rental real estate enterprise will be treated as a trade or business if the following requirements are satisfied during the taxable year with respect to the rental real estate enterprise:

  1. Separate accounting of income and expenses are maintained for the rental real estate enterprise.
  2. 250 or more hours of rental services are performed for taxable years beginning prior to January 1, 2023 with respect to the rental enterprise. 
  3. For taxable years beginning after December 31, 2022, 250 or more hours performed in respect to the rental real estate enterprise in any 3 of the 5 prior consecutive years.
  4. Contemporaneous records are required, including: time reports, logs and similar documents regarding the following:
    1. hours of all services performed
    2. description of all services performed
    3. dates services were performed, and
    4. who performed the services

Of course, contemporaneous records are a bit hard to produce when the rules were not in place until after the tax year concluded, and therefore the records do not need to be contemporaneous for tax year 2018. I recommend going over 2018 ASAP to create a log of all services performed.

 

What Counts for the Safe Harbor

Not all activities count toward the 250 hour requirement for the safe harbor. 

Rental services performed by the taxpayer or by employees, agents, and/or independent contractors of the taxpayer all count toward the 250 hour safe harbor requirement. 

Rental services for the rental real estate safe harbor include:

  1. advertising to rent or lease the property/s
  2. negotiating and executing leases
  3. verifying information from prospective tenants
  4. collection of rents
  5. daily operation, maintenance and repair of the property/s
  6. management of the property/s
  7. purchase of materials
  8. supervision of employees and independent contractors.

Keep in mind the time supervising employees and/or contractors only includes your time supervising. The hours performing services by employees and independent contractors do not count toward your hours.

 

Activities that Don’t Count as Rental Services

Several activities do not count as rental services as applied to the 250 hour requirement:

  1. travel to and from the property/s
  2. financing activities
  3. investment management activities (financial statement review; property search; and procuring and planning, managing or constructing long-term capital improvements)

Generally, things that are easily fudged are disallowed. Saying you spent many hours reviewing the books or driving to the property will not benefit you. Saying you spent x number of hours planning capital improvements to the properties also do not count toward the safe harbor.

 

Other Exclusions

Real estate is better than ever with the new tax laws. Discover the advantages to 199A. Get your tax break today.Several situations are excluded from using the safe harbor. 

Any personal use of the property during the year excludes use of the safe harbor.

Triple-net leases are also excluded from the safe harbor. A triple-net lease is defined as a lease agreement that requires the tenant to pay for all or part of the taxes, fees and insurance, and the tenant is responsible for 

maintenance requirements in addition to rent and utilities. Since most commercial property is leased triple-net, the safe harbor option is unavailable, but may still qualify as a trade or business as shown next.

 

How to Still Claim as a Trade or Business

Since so many tax dollars are riding on the line it is important to determine if you qualify for the 199A deduction. The safe harbor is just that, a safe harbor. Just because you don’t qualify for the safe harbor does not mean you do not have a trade or business.

There are some similarities in this safe harbor with the material participation tests under the passive activity rules. While the numbers between this safe harbor and the material participation tests are different, we can still gather guidance by reviewing the facts and circumstances in determining if the activity is a trade or business.

Earlier last summer while waiting for the IRS to provide guidance on what a “trade or business” is, I decided to build a policy for my office. My conclusion was that investment property (reported on Schedule D when sold) was not a trade or business and property that is treated as a sale of business property when sold (reported on Form 4794) is a trade or business. With the recent IRS guidance I am forced to tighten my definition of a trade or business in situations not covered by the safe harbor.

The IRS actually uses the words “trade or business activities” in their material participation tests. In other words, they say:

You materially participated in a trade or business activity for a tax year if you satisfy any of the following tests:

Whereas the safe harbor for 199A rental services say you need 250 hours, the first material participation test says 500 hours. I think it is safe to say we can use 250 hours when not using the safe harbor as well.

But you can still be a trade or business if you put in fewer than 250 hours if the material participation tests are a valid ancillary. 

Material participation test #3 says if you put in 100 hours, and is more than anyone else in the activity, you pass the test and materially participate.

According to test #2, if you put in substantially all the participation in the activity you pass.

There are additional tests to determine material participation. For trade or business issues I think it is reasonable to use the material participation guidelines, whether it be a small business or rental property. The safe harbor is a bit easier to pass for 199A based on hours, but if you meet the guidelines in any of the material participation tests you have substantial grounds for claiming you are a trade or business since the IRS already recognizes this in another area of tax application.

 

Final Considerations

Section 199A, the Qualified Business Income deduction is one of the most complex pieces of legislation to hit taxpayers in a long while. I dealt with one narrow subsection of the regulations. 

It might be a good idea to hire a tax professional for at least one year if you own a business and or rental property to deal with the litany of tax issues surrounding 199A. Even if an extension is required and your taxes are not filed until later in the year.

Here are a few issues not covered in this post that you will want to discuss with your tax professional:

  • Tier #1, #2 and #3 for small businesses
  • Specified service trades or businesses (SSTB)
  • Form 1099 (If a rental in not a trade or business then Form 1099 reporting can sometimes be avoided. However, you want to be a trade or business for 199A reasons so if you don’t file Form 1099 with contractors the IRS may disallow the deduction because you didn’t act like a trade or business)
  • Contributed property to an entity has special rules
  • Special rules apply to like-kind exchanges and involuntary conversions
  • Special considerations for basis of inherited property
  • Net operating losses affect 199A
  • Capital gains and losses may affect 199A
  • Amended returns are not allowed to initiate aggregation, but aggregation can be used in future years
  • SSBTs are better defined in the final regulations
  • and more. . . 

 

As promised, here are the reports from the IRS. You can read Notice 2019-07 as well as I. It is a short 10 page document and worth a read if you have rental properties. Less readable is the final regulations on 199A, coming in at 248 pages.

If you ever have trouble falling a sleep one evening just pick up the final regs. You’ll be out cold in minutes.

 

 

More Wealth Building Resources

Credit Cards can be a powerful money management tool when used correctly. Use this link to find a listing of the best credit card offers. You can expand your search to maximize cash and travel rewards.

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

cost segregation study can reduce taxes $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Worthy Financial offers a flat 5% on their investment. You can read my review here. 

If You Love Spending Money This Will Make You Rich

5 spending habits that can make you wealthy. How you spend your money determines how rich you will be. Right spending habits increase your wealth. #wealthyaccountant #spending #spendinghabits #investing #debt ##indexfunds #incomeproperties #rentalproperty #guilty #guiltyfeelings #buyersremorse“Should I feel guilty when spending money?” It’s a common question when I consult with clients. They are so tuned into frugality they sometimes start associating negative feelings with money. It’s a bad thing to start feeling.

Spending money is NOT an evil activity! In modern society we have it so easy that we tend to either overspend (the vast majority) or become hyper-frugal (a significant percentage of the demographic reading this blog). Both lifestyles are unhealthy. Overspending leads to serious problems when the bills come due and income might not keep up. Debt is a serious issue I ask clients (and readers) to consider purging. The opposite of overspending is the hyper-frugal drive. This can suck the pleasure out of life as fast as a heavy debt burden.

I tend toward the frugal side of the equation and get called out on it periodically, too. Sometimes I do things just because it’s the cheaper choice. If I were as smart as I think I am I would reconsider such decision-making. Frugal isn’t always the best answer.

Frugality for me is more about my hate for shopping. When I spend I know exactly what I want and side purchases are never a distraction.

Buying a good or service feels good even for a frugal accountant like me. I needed a longer breaker bar (torque bar) to get the lug nuts off a tractor tire so I can take it in for repair. The breaker bar I have is only 14 inches; the one I bought is 30. By the time you read this I might have that tire off with my new piece of equipment. Yes, I’ll save money on a service call by getting the tire to the shop, but it still feels kind of good knowing I have a shiny new tool in the garage.

But spending is a problem for many people. Frugality is a forced habit at best for the majority. Economically enforced austerity gives way to bad spending habits when normalcy returns. The cycle is familiar and we know it while we do it. If only we could stop.

Since most people enjoy spending money I thought I’d share 5 ways you should spend because this kind of spending makes you richer. In fact, if you don’t adopt these spending habits I outline below you will suffer serious personal finance issues. Those who have money will realize they were already spending this way. For the rest of you, please come along. I’m going to show how you will want to spend that money burning a hole in your pocket.

Maintenance

This may sound like common sense, but too many people defer spending to their detriment. Every so often you should change the oil in the car. It runs better and lasts longer when you do. When the roof needs replacement frugality is not your friend. The structural damage follows shortly after and gets very expensive. Then you get to spend a lot of money for no additional value. That is not a good spending habit.

5 ways spending can make you rich. Spending habits can lead to debt or wealth. Here are the secret spending habits of the wealthy.. #wealthyaccountant #secrets #wealthy #spending #spendinghabits #habits #debt #moneyDo-it-yourself (DIY) projects are a good opportunity to spend. One of the cables broke on my garage door recently. I bought new cables and discovered I didn’t have tools or the recommended bars to loosen and tighten the spring. I broke down a bought a pair (you need two) to finish the job. Now I need to keep them safe for a distant future event when I need to work on a garage door again. The cost was only $15, but it is spending. The spending saved me the cost of a service call which would have been significantly more. Some spending is good spending and increases your wealth.

The same situation occurred at the office this summer when I wanted to do some light landscaping. The place really needed it. Clients have a better opinion of an establishment with appealing décor. I acquired several quotes which all came in over $10,000. (And it wasn’t that big of a job!) I decided to do the job in-house. The cost of dirt and river rock and some seed money for some extra helping hands was under $2,000. I have several huge rolls of felt in the barn I used and unused treated fence posts from a previous farm project so that cost nothing extra. In the end I spent a couple thousand, assuaging my spending itch, and created over $10,000 in value; more if you count the added business an attractive building can bring in.

Maintenance and DIY projects are a perfect way to spend money in a way that creates value. If I would have written a check for $10,000 to landscape the office it wouldn’t have felt as good. I got the satisfaction of a job well done and the opportunity to order 10 yards of top soil and two orders of river rock. There were multiple spending opportunities for the same job. For people with an itch to spend, this might be a good way to kill two birds with one stone.

Pay Down Debt

I’ve preached this line often before. Loan payments are not completely new spending. The interest is, but it doesn’t feel like fun spending. You get nothing for the interest spending: no pretty baubles or service or vacation. Nothing. Your wealth just disappears.

The act of spending is addicting to many. Rather than spend on more stuff and putting it on the credit card at 18%, consider tricking your brain into spending the right way. Here is what I propose. Spending is about wanting something. Some people enjoy the shopping experience. Either way, turn these desires into a wealth creating machine. For the shopping addict, lay out all your debt and obsessively review your balances. Create an aggressive spending payoff habit. Set your payments up on automatic, but also send in extra whenever an extra nickel crosses your path. Turn it into a game! Have fun with this. Instead of building debt, turn debt elimination into an exciting adventure.

If shopping doesn’t trip your trigger then you probably spend just to have something new. I have something shiny and new you’re going to want: a debt free balance sheet! I mean it. Instead of a new boat, roll up your sleeves and butcher those bills. Remember, it is easier to enjoy a new toy when you don’t have to work to pay off the toy, plus interest.

Investing

Once you pay down debt you might be tempted to return to old habits which caused the financial problems. I say, “Nyet!”

The newfound habit you used to eliminate debt is a good behavior for proper future spending habits. Turn investing into an automatic wealth creating machine. Automating investing doesn’t always satisfy the itch to spend. There is a solution.

It may be hard to believe, but there was a time when I enjoyed spending a bit more than I tend to nowadays. Money was rolling in and times were good in the 1990s. I was smart enough to know good times don’t last forever so I devised a plan to satiate my spending desires with intelligent cash allocation.

These are the 5 things you need to spend on if you want to be rich. The 5 secret spending habits wealthy people use are available to anyone. Frugality isn't the entire game. The wealthy spend. They spend right. #wealthyaccountant #frugality #frugalliving #wealth #money #passiveincome #spending #spendinghabitsTax season was always a good time of year. My mutual funds were automated, but I needed a home for my excess cash so I wouldn’t be tempted to spend it. My solution: dividend re-investment plans (DRIPs). I wrote checks to all my DRIPs. It gave me great pleasure to finish my day with a spending splurge. I’d write a check to JNJ, Aflac, Phillip Morris, Wrigley (damn you, Warren) and more. As fast as it came in I sent it out. I don’t know what you spend your money on, but I have a nasty habit of buying as much stock as I can get my hands on. For the record, it’s a good habit to have.

DRIPs aren’t what they used to be. Brokerage accounts generally automate re-investment of dividends and many DRIPs now have fees. There is still a solution. Set a minimum amount you can easily invest every month. Automate the process. Then either write a check every time money comes in or log in and set up a transfer. Trust me, you’ll have so much fun spending on your index fund. The best part? Instead of paying interest on your purchase you’ll be paid dividends instead. Oh, the joy!

Turn investing into a game. Real wealth creation is built on the proper allocation of capital. The bank is fine for short-term and emergency funds. But your serious money needs to be working hard building a better world and the only way to do that is to own a piece of great businesses.

Another spending game to consider is investing funds you planned on spending foolishly. Excessive dining out or drinking in bars can be swapped out for an index fund investment. I’m not telling you to forgo a pleasurable life. God forbid! All I’m suggesting is that you switch some consumer spending for investment spending. And besides, you know as well as I you will enjoy those dividend checks more than interest payments.

Income Properties

If you have an itch to spend, income properties are for you. Many moons ago I owned a city of real estate in my portfolio. From personal experience I can attest you get plenty of spending opportunities when you own real estate.

Your primary residence is different from income property. Money you spend on your primary residence (or second home) comes from another source and can run dry. Income properties have—wait for it—their own income stream to fund expenses. If you have a serious spending itch, real estate done properly can scratch that itch raw.

You still need to buy properties right! Stupid income property purchases will force really bad spending even when you discover how bad the spending is and want to stop. Sometimes you can’t. But a small portfolio of investment property can give you plenty of opportunity to shop and buy. Researching the right property should be a priority. Once you own the property there are always things that need to be paid for: property taxes, utilities, insurance, repairs and maintenance. A property manager can do all this for you, but you can write the check yourself if you insist. Even still, you can review your monthly statement from the manger which will show all the spending. It should serve as a powerful ointment for your spending itch.

Small Business/Side Hustle

Okay, hustlers! Nothing beats spending opportunities than a small business or side gig. Even a frugal guy like me still manages many hundreds of thousands of dollars in annual spending just by owning a small accounting practice. Every two weeks payday comes around and I get ample reminders on how to spend my money.

These smart spending habits can put serious money in your pocket. Spending on the right things can increase your wealth rather than build debt. Spend your way to riches! #wealthyaccountant #smart #spending #happiness #dreams #frugality #frugalA side gig or business is an easy way to alleviate the desire to spend. Maybe too easy. While I can brag I spend $250,000 in my business, it needs to be brought into perspective. I’ve seen too many people over the years start a business, spending like mad to get it up and running. It soon becomes apparent my client isn’t ever going to make a sale. He’s going to keep spending until he’s broke without ever actually starting the business. Then he asks if it’s deductible. (Not if it was a hobby or you treated it as such.)

Still, business owners are spending daily. At home my wallet has moths. At the office money is moving constantly. Office supplies are replenished, utilities are paid, property taxes come due, employees get paid, IT needs money. The list goes on and on. A frugal habit goes a long way toward profitability in a business. It’s easy to spend; not so easy to bring it in.

Spending/shopping addiction is a serious problem with many consequences. Shopping is a waste of time compared to time spent with family and friends. Shopping has its place as long as it doesn’t rise to addiction. Business has a natural built-in need to allocate money. If you can run a “real” business or side hustle you have my blessing. Before long you will lose that desire to spend. Take it from a three decade business owner. Spending gets old real fast when it becomes a job. (You know; a job. That thing you want to take early retirement from.)

Coda

Spending in and of itself is not wrong! Overspending is a bad habit and even a sickness. Excessive frugality is a bit of a sickness too. Careful readers may have noticed that from a certain unnamed accountant over the past few years.

I’m not here to tell you to never spend. What I want for you, kind readers, is a healthy relationship with money and spending. Reducing debt to background noise is important. Investing for your future and that of your family is imperative.

Spending easily becomes a job! Money is a powerful tool to help you live a quality life. Too much or too little is a problem. Using the 5 ways to spend listed above will make you wealthier. That is what we are about around here: quality of life which is the true meaning of wealth.

Finally, can you do me a favor? If you think this is as important as I do, go back to the top of this post and use the buttons to share on social media. You can pin the placards to Pinterest, as well. Help me spread the word. Let’s make the world a better place where people control their spending and build powerful, nurturing money habits.

Thank you.

 

More Wealth Building Resources

Personal Capital is an incredible tool to manage all your investments in one place. You can watch your net worth grow as you reach toward financial independence and beyond. Did I mention Personal Capital is free?

Side Hustle Selling tradelines yields a high return compared to time invested, as much as $1,000 per hour. The tradeline company I use is Tradeline Supply Company. Let Darren know you are from The Wealthy Accountant. Call 888-844-8910, email Darren@TradelineSupply.com or read my review.

Medi-Share is a low cost way to manage health care costs. As health insurance premiums continue to sky rocket, there is an alternative preserving the wealth of families all over America. Here is my review of Medi-Share and additional resources to bring health care under control in your household.

QuickBooks is a daily part of life in my office. Managing a business requires accurate books without wasting time. QuickBooks is an excellent tool for managing your business, rental properties, side hustle and personal finances.

A cost segregation study can save $100,000 for income property owners. Here is my review of how cost segregation studies work and how to get one yourself.

Worthy Financial offers a flat 5% on their investment. You can read my review here.