IRS 20% off Tax Sale! Save on your Passive Income Taxes
Yes, your rental property income applies. Want proof?
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Hi, I’m Dan
And I’m Brooke with the High Yield Real Estate Investing Podcast
In 2017 the Tax cut and JOBS act was passed by Congress. In this episode we’re going to talk about a great tax cut that anyone with passive income is benefitting from. Think of it like the IRS throwing a 20% off sale on your business income taxes. It’s called the Qualified Business Income Deduction. Let’s dive right in!
The Qualified Business Income deduction or, if you’re an accountant, the section 199A Deduction, allows non-corporate taxpayers to deduct up to 20 percent of their Qualified Business Income (we’ll just call it QBI for brevity) and 20% of qualified REIT dividends. If it’s income earned from a C corporation, or income from your W2 job then you won’t be able to take this deduction from those earnings. But any qualified income from a Sole Proprietorship, partnership, S Corp, LLC, or LLP applies. All of those entities mentioned are pass-through entities. This means the entity itself pays no tax and the tax burden is passed through the entity to the individuals who own it. Since this is the IRS, of course there are some ifs, ands and buts as to when and how you can take this deduction. But first, let’s define what Qualified Business Income is.
To make it simple, QBI is whatever is left after deducting expenses and depreciation from the revenue of your business-- with exceptions. Exclusions from QBI include: capital gains and losses, certain dividends, interest income, and W-2 income. Though it may seem obvious, you also need taxable income for the year to garner this deduction. If you show an overall loss for your QBI then you aren’t able to take the deduction; instead, you are allowed to carry the loss forward into the subsequent tax year.
To make it complicated, it has to be income from a qualified trade or business, which the IRS actually doesn’t define. But the Supreme Court defines a qualified trade or business as any activity conducted with continuity and regularity for the primary purpose of making a profit or earning income. Basically, anything you consider business qualifies; there isn’t a long list of qualified businesses being updated in the tax code or anything. If you wanted to start a for-profit league of synchronized-underwater-basket-weaving tournaments, then that would meet the requirement of a qualified trade or business. And yes, your real estate investment activity qualifies as well.
However, there are three exceptions to what qualified businesses can take the 20% deduction.
1. Any C corporation (The entity itself is taxed so it’s not pass-through)
2. if your trade or business performs the service of an employee
3. the principal asset of the business is the skill or reputation of the owner or employees and your income is over a threshold. If you’re a doctor, lawyer, accountant, athlete, performing artist, athlete, investment guru, etc. and you make over $326,000 if married and $163,000 if single in 2020. If you fall into one of those fields which the IRS defines as a specified services trade or business, or SSTB, and you make over that income then things get a bit complicated and we can’t explain it here. So go ask your accountant since your personal tax situation will change the answer greatly.
So how do we calculate the deduction? It’s rather simple actually. As long as you have other taxable income under the threshold we mentioned, you just take 20% of your QBI you earned for the year and you get taxed on that. Let’s say that after expenses and depreciation your rental income for the year is 100,000. Well, now it’s reported to the IRS as only being 80,000. If you’re in the 24% tax bracket for the year, you just saved yourself $4,800 in taxes. Much like depreciation, you’re legally sheltering income you earned from being taxed. Again, this deduction isn’t available to your W2 income. There actually aren’t many ways to reduce your tax burden on your W2 income. So here’s yet another reason to start investing, even if it’s not in real estate, and move your income over into the passive side of the tax code and away from the earned side.
But here’s the bad news which we saved for last. This 20% deduction goes away in 2025 unless Congress acts to keep it alive. Also, if your taxable income is over $415,000 then you don’t qualify for this deduction at all. Sorry.
Thanks for listening. If you want to learn more, go to our website highyieldre.com . There, you’ll find a complete list of previous episodes and transcripts. Don’t forget to subscribe to get updates on our latest episodes. You can also find us through your favorite podcast service or Youtube. You can contact us through our website or by emailing info at highyieldre.com