the economic consequences of the COVID-19 crisis and civil unrest could cause many rental property accumulates tax losses in 2020 and possibly beyond.
Nothing new here.
he can deduct mortgage interest and property taxes on rental properties. You can also cancel all standard operating expenses that accompany the rental property: utilities, insurance, repairs and maintenance, upkeep and maintenance of outdoor spaces, etc.
What about depreciation and amortization?
For many rental property owners, the tax savings bonus is the fact that you can amortize the cost of residential buildings for 27.5 years, even if (wait) their value increases. In general, you can amortize the cost of commercial buildings for 39 years.
Example: you own a small apartment building that cost $ 1.5 million off-site. The annual capital cost allowance is $ 54,545 ($ 1.5 million / 27.5).
The deduction can protect this amount of positive annual cash flow from income taxes. Therefore, depreciation and amortization are good tax savers, especially if you own an expensive property or multiple properties.
Variation: As noted above, commercial buildings are expected to depreciate over a much longer period of 39 years. However, the annual depreciation for a commercial building of $ 1.5 million is $ 38,462. The deduction can protect this annual cash flow from income tax.
Can I request a 100% depreciation of the first year premium?
Yes, for qualified improvement property (PAQ) expenses in a non-residential building. The Coronavirus Rescue and Economic Relief Act (CARES Act) included a retroactive correction to the legal language of the Tax and Employment Reduction Act (TCJA). The correction allows a much faster depreciation of commercial property qualified for improvement (QIP) put into service in 2018-2022. The PAQ is defined as an improvement to an interior part of a non-residential building that is put into service after the building is put into service. However, the PAQ does not include any expenditure attributable to: (1) the extension of the building, (2) any elevator or escalator, or (3) the internal structural framework of the building. Thanks to the correction made to the CARES law, you can cancel the entire cost of the PAQ during the first year, because it gives rise to a 100% depreciation of the first year bonus.
Alternatively, you can choose to amortize the QIP for 15 years using the straight-line method. This alternative might make sense if you expect higher tax rates in the years to come. Discuss your QIP depreciation options with your tax professional.
What else should I know about depreciation and amortization?
You are asking good questions. There is more. The TCJA increased the first year capital cost allowance in section 179 for eligible real estate expenses to $ 1 million, with annual adjustments for inflation. The maximum adjusted for inflation for fiscal years beginning in 2020 is $ 1.04 million. The section 179 deduction privilege potentially allows you to deduct the total cost of eligible real estate expenses in the first year. I say potentially, because the deductions from section 179 are subject to several restrictions. Ask your tax specialist.
The TCJA also broadened the definition of eligible property to include roofing expenses for non-residential buildings, HVAC equipment, fire and alarm systems and security systems.
Finally, the TCJA further broadened the definition of eligible property to include tangible and depreciable personal property used primarily to provide housing. Examples of such properties include beds, other furniture, and appliances used in apartment buildings.
Can I claim the allowable deduction for business income (IQB) on my net rental income?
Perhaps. For 2018-2025, the TCJA has established a new personal deduction based on eligible business income (QBI) transferred to your personal 1040 form from a business transfer entity (i.e. a sole proprietorship, LLC treated as a sole proprietorship for tax purposes., partnership, LLC treated as a partnership for tax purposes, or corporation S). The deduction can reach 20% of the QBI, subject to restrictions that apply to higher income levels. For a while, it was unclear whether you could claim QBI deductions based on the net rental income that was passed to you by one of the transfer entities listed above. The IRS has finally published a user-friendly guide for taxpayers that allows QBI deductions in most of these cases, but you have to follow complicated rules to reap the benefit of the tax savings. Like your tax specialist for more details.
What about passive loss rules?
If your rental property is taxed (most properties are taxed, at least during the first years and during the years when the economy is in trouble, like now), things can get complicated. The so-called passive loss of activity (PAL) rules can come into play. Losses related to rental properties will generally be classified as passive losses.
Generally, PAL rules allow you to deduct current passive losses only to the extent that you have current passive income from other sources, such as positive income from other rental property or gains from them. sale. Passive losses that exceed passive income are suspended until you have sufficient passive income or sell the property that produced the losses. Conclusion: PAL rules can defer any tax savings on the loss of rental property, sometimes for years. Fortunately, there are several exceptions to the PAL rules that can allow you to deduct losses on rental property as soon as possible. Your tax specialist can explain the exceptions and help you plan for eligibility, if possible.
Is the end of the bad news?
Suppose you succeed in removing the obstacles imposed by the PAL rules on the loss of your rental property. So far, so good. But the TCJA has put in place another obstacle which it must also remove in order to deduct these losses. For taxation years starting in 2018-2025, you cannot deduct an excessive business loss in the current year. An excessive commercial loss is a loss that exceeds $ 250,000 or $ 500,000 for a married couple filing a joint return. Any excess commercial loss is carried over to the next financial year and can be deducted in accordance with the rules on net operating losses (NOL). This loss rejection rule is applied after applying the PAL rules. So if the PAL rules don't allow your rental losses, that rule isn't a factor.
COVID-19 relief: Fortunately, the CARES Act suspends the rule against disallowing excessive commercial losses for losses that occur during fiscal years beginning in 2018-2020. It's good news.
What is the agreement with the net operating loss (NOL)?
Suppose you can successfully remove the two above barriers to losing your rental property. We are talking now because you can usually use these losses today to offset taxable income from other sources. If the losses for the year exceed income from other sources, you may have a net operating loss (NOL) for the year.
COVID-19 relief: The CARES law grants a five-year reimbursement privilege for a NOL that occurs during a fiscal year starting in 2018-2020. Therefore, you can take a NOL from one of these years to a previous year, deduct it, and recover some or all of the federal income tax paid for the reporting year. Since federal income tax rates were generally higher in the years preceding the coming into force of the TCJA, NOLs carried over to these years may be particularly advantageous. The TCJA started from the 2018 exercises.
What if I have positive taxable income?
Ultimately, your rental property should start generating positive taxable income instead of a loss, because rising rents will exceed your deductible expenses. Of course, you have to pay taxes on this income. But if you've accumulated suspended passive losses in previous years, you can now use them to offset your passive gains.
Another good thing: the positive taxable income from rental property is not affected by the dreaded self-employment tax (SE), which applies to most other non-profit companies. The SE tax rate can be up to 15.3%. Something to avoid when possible.
One bad thing: positive passive income from rental property owned by a high-income individual can be affected by the net investment tax (NIIT) of 3.8%, as well as profits from the sale of properties can be affected by NIIT. Ask your tax specialist.
That's it: most of what you need to know about federal tax issues that can come into play for rental property owners. The economic fallout from the COVID-19 crisis and the recent civil unrest increases the likelihood that rental properties will experience losses in 2020, but tax relief provisions could help soften the blow.